Beyond Bulls & Bears

Fixed Income

Theresa May’s Shock Defeat Threatens Further Volatility

In the sort of unexpected twist that observers have come to expect from elections recently, UK voters have dealt a bitter blow to Prime Minister Theresa May, robbing her of her narrow parliamentary majority. With further financial market volatility on the horizon, David Zahn, head of European Fixed Income, Franklin Templeton Fixed Income Group, offers his view of the situation.

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Theresa May’s gamble didn’t pay off. She had hoped that a resounding election victory and an increased majority in the House of Commons would give her a mandate to pursue her own political agenda and, in particular, strengthen her hand in negotiations to secure the United Kingdom’s withdrawal from the European Union (EU).

But those plans are in tatters and instead, slightly less than a year after the country voted to leave the EU, the United Kingdom has been plunged into further political uncertainty.

We expect the pound to plummet and gilt yields to decline as investors embark on a so-called flight to safety. Overall, we think so-called risky assets, such as equities, are likely to underperform.

Much-Needed Focus

The prospect of a hung parliament, resulting either in a minority government or a coalition, paints a picture of an administration not in complete control during a period in which the United Kingdom needs its most focused administration for 70 years.

More Scrutiny on Brexit Strategy

Instead of securing an easier passage for any Brexit deal, as May had hoped, this result increases the likelihood of Members of Parliament (MPs) more aggressively scrutinizing the Brexit progress. It also raises the possibility of Parliament rejecting an unpopular deal.

In our view, that result would significantly tie the hands of UK negotiators. MPs would be more likely to demand more transparency on the UK side of the negotiations, which will be a boon to the EU negotiators. This is likely to make the prospect of a deal that is beneficial to the UK tougher to achieve.

The Clock Is Ticking

The harder it is for the UK government—whatever its hue—to negotiate, the more likely we anticipate a “hard Brexit” scenario to be, leaving the United Kingdom without a deal to replace the current European trade agreements.

That outcome would likely result in the pound selling off further and UK bond prices surging. And although that prospect might seem some time off, yet, it’s worth remembering that the clock has already started ticking, and there are only 20 months left. We’re four months into the Brexit process and have officially accomplished nothing as yet.

Worryingly for the UK authorities, this election result is likely to play into the hands of the EU’s Brexit negotiators. They will see the UK doesn’t have a strong leader to negotiate with and could be emboldened to take a tougher line.

The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments.