The Conservative Party has achieved a thumping victory in this election, with a majority of 80 seats. Financial markets had certainly foreseen a Conservative win, with every poll indicating as much, but the size of the majority is much larger than had been expected.
The popularity of the SNP, coupled with historic wins for Prime Minister Boris Johnson in the North East, resulted in severe losses for the Labour Party. Labour blamed Brexit, but the real fly in the ointment appears to have been the party’s unelectable leader.
The FX market saw resultant volatility, with sterling appreciating 2% against the dollar and euro, however the gilt market reacted far more calmly. A sharp bond sell-off was quickly greeted with investor-buying focused on longer maturities, resulting in a flatter yield curve.
The rationale behind this strategy was that a larger majority would give Boris the means to push his Withdrawal Agreement bill through unchallenged and would remove the political uncertainty that has worried members of the Monetary Policy Committee, reducing the risk of an interest rate cut in early-2020.
Additionally, the removal of Corbyn reduces the likelihood of monstrous gilt issuance, which would cause the yield curve to steepen significantly.
None of this is to suggest that Johnson and Chancellor Sajid Javid will not also loosen the purse strings, but we expect them to be more measured than their Labour Party counterparts.
We now expect the “London 2012” Boris to re-emerge, with more business-friendly rhetoric in the first half of 2020 that would see 10-year gilt yields rise to 1.20%.
We also expect the yield curve to flatten as rate cuts become priced out by the market and LDI players buy longer-duration assets knowing that long-dated first quarter supply is limited.
The strong pound clobbered short-dated inflation expectations, and we expect this to continue in the first half of next year as the RPI reform consultation weighs on investor demand for inflation hedging.
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