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With just a few days to go until the UK General Election the polls are suggesting a hung parliament with the likelihood that the Conservatives will just about win the most votes and seats, but not enough to form a majority on their own. In addition, the SNP continues to look the most significant minority party with possibly over 50 seats.
The Cabinet Manual is not a flat pack furniture assembly guide, but a plan to follow in the event that no single party wins an overall majority. The main point is that a government must be able to command the confidence of the House of Commons to get the Queen’s Speech passed. Furthermore, Prime Ministers hold office until they resign. The incumbent government is also entitled to wait until the new Parliament has met, but should resign if it becomes clear it cannot command the confidence of the House of Commons. The options are then either a formal coalition, an informal agreement or a single party minority government. We all have a pretty good idea of how a coalition government functions from the existing Conservative and Liberal Democrat partnership. The press reports David Cameron and Nick Clegg are preparing talks on a new coalition within hours of Thursday’s election and may also include the DUP this time but there will be no overall majority.
If there were to be a minority Conservative government this would be known as confidence and supply. Basically a minority government can survive via a deal by which a third party, or several, undertakes not to vote against a budget (supply) or to vote against the government in a vote of no confidence. The Fixed Term Parliament Act of 2011 means future parliaments should last a full five years unless the opposition tables a vote of no confidence or two-thirds of MPs call for and agree to another general election. Ed Miliband has said that a formal Labour coalition with the SNP is not going to happen but does that rule out an informal agreement? Alternatively, could a Conservative and Liberal coalition work with the SNP given the coalition’s view on a United Kingdom and the latter’s wish for an end to austerity?
Which got us thinking. If there is no clear majority post the 7th May then the UK Parliament could resemble flat pack furniture. Who has the instructions to follow? Expect lots of shouting and arguing!
What have we been watching?
A quieter week with most European markets closed for the May Day holiday. May Day is quite ironic really given this is also an international distress call.
Talking of distress, the path of US interest rates continues to be the main focus for global investors, overshadowing both Greece and the UK Election. Disappointing US Q1 GDP growth has seen US interest expectations slip again, with the US Dollar weakening against both the Euro and Sterling. Many US companies have reported the challenges of a Dollar headwind in the current US results season. By comparison, the weakness of the Euro against the Dollar over the last six months has led to some pretty punchy growth assumptions for European company earnings, so this more recent reversal does leave European equity valuations looking a little stretched. The Euro has climbed back to a two month high against the US Dollar. In addition, European bond yields have also jumped sharply off their recent lows. Indeed, only Switzerland and Denmark now have 5 year bonds with a negative yield. Is this a correction from abnormal lows or the start of a trend?
Within Europe it was always going to be a case of who would blink first, the Germans or the Greeks and it looks like the latter. The Greek PM overhauled his bailout negotiating team, side-lining the finance minister, and handing responsibility for co-ordinating this new team to a member of his own inner circle. The move comes as senior Greek ministers publically acknowledge they might be forced to accept economic measures that they have been seeking to avoid and will have to start preparing the Greek electorate for concessions in order to secure bailout funds. The Greek PM appeared on television and indicated that he thought an interim deal would be in place by May 9th ahead of the next payment to the IMF.
In the UK, Q1 GDP slowed to +0.3%, the weakest reading since Q4 2012 reflecting sluggish growth from financial services and a dip in construction activity. However, this was the first estimate and is therefore likely to be revised.
In Europe the distorting effect of ECB QE continues, with Poland, the first emerging market to announce that it intends to sell a three year bond at a negative yield. Poland is currently rated six notches below Germany’s AAA rated bonds. German bond yields continued to rise from their recent record low climbing back above 0.4%, back above the pre-QE level, which mirrored a ‘pretty significant’ move in other European bond yields. ECB QE has distorted the bond market and with economic data adding to evidence that Europe may have avoided a deflationary slump, together with improving credit conditions and consumer expectations then there has been something of a sell-off in European bonds.
In the USA, the trend of soft data continued with Q1 GDP growth of just 0.2% which was well below forecast. While the effect of bad weather on the construction industry, the West Coast port strike and stronger US Dollar was more severe than expected, consumer spending was also slower than forecast despite lower gasoline prices. The US Fed assessment of the slowdown, given the temporary nature of these factors was ‘transitory’. While the Fed expects economic growth and inflation to rebound, until they see evidence of such then they are unlikely to be in a hurry to impose the first interest rate hike. While the Fed has ‘kept the door open’ to a possible interest rate hike, many in the US market are not now expecting such a move this summer. In addition, subsequent economic data was pretty tepid, with consumer spending showing a weaker than expected pick-up in March and inflation undershooting target.
The US reporting season continues to be mixed with cash rich companies like Apple increasing cash returns to shareholders while exporters such as Whirlpool and Pfizer trim estimates due to the strength of the US Dollar. The technology sector was hit by big falls in Twitter and Linked-In.
In China, factory activity held steady in April at the same level as March, having contracted in the first two months of the year. The official GDP growth target remains around 7% although many Asian fund managers believe growth to be much lower particularly given the recent weakness of many independent measure such as electricity consumption which has been falling. Nonetheless, expectations continued to be supported by hopes that the Chinese authorities intend to support the economy with further stimulus measures.
Finally, we do not expect the election to derail the consumer led recovery while any Sterling weakness would be beneficial to UK exporters and overseas earners. Nonetheless, a period of increased volatility is likely post the 7th of May and overseas investors may be more inclined to continue to switch assets from the UK to Europe. Nonetheless, UK interest rates remain at historic lows while the Bank of England is likely to remain supportive of financial markets and the UK economy well into 2016.
The UK will probably continue to face uncertainties over potential ‘Brexit’ risk and, given the likely SNP votes, lingering potential for UK break up.
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