The honeymoon didn’t last long. As the dust settles on Boris Johnson’s emphatic election victory last week, the euphoria in financial markets has quickly given way to something more ambiguous.
Sterling, which notched up one of its biggest ever one-day gains last Friday, gave it all up this week. After some minor gyrations, the bond market too is roughly back to where it started, with the 10-year gilt yield ending the week at 0.79 per cent.
In stock markets, however, the party has lasted longer, with the FTSE 100 up 3 per cent since last Thursday’s close. The mid-cap FTSE 250 — a better barometer for the UK economy than its larger cousin — has added 4 per cent.
This carries echoes of a global disparity between equities and bonds. For much of 2019, stock markets were scaling record heights while fixed income markets screamed that recession was around the corner. The UK may be simply catching up with the rest of the world.
But the moves since election day are also a useful guide to what has changed — and what has not — in the minds of investors.
Start with the pound. The basis for the initial post-election rally was clarity — on the outlook for the domestic economy and, crucially, for the process of leaving the EU. Mr Johnson’s very comfortable victory over Labour’s Jeremy Corbyn, the argument ran, would give him a big enough majority to ignore hardliners in his party and take his time over getting Brexit right. But the prime minister’s promise earlier this week to rule out any extension to the one-year transition period quickly drove a coach and horses through that theory, and was the catalyst for the U-turn in the pound.
As Rupert Harrison of BlackRock put it, the economic benefits of a reduction in uncertainty require the government to actually reduce uncertainty. “[They] need to realise their words have consequences,” he said. The era of sterling as a politically driven currency, with emerging-market levels of volatility, looks set to continue.
The contrast with equity markets has been striking. Not only have UK stocks added to their post-election gains this week, but bankers are already talking about a 2020 dealmaking boom as the lifting of political uncertainty unleashes animal spirits.
One explanation for the gains is the mostly unloved status of UK equities over the past three years, which have consistently ranked as the least favoured market among big investors.
Bank of America’s closely watched survey of fund managers this week showed that global investors had already been closing their underweight position in UK stocks in the run-up to the election, in anticipation of a Conservative win.
These shifts in portfolios probably reflect a pricing out of “Corbyn risk” rather than an arrival at Brexit’s sunlit uplands. The prospect of the most leftwing Labour leader in living memory entering Downing Street with a programme of huge tax rises and sweeping nationalisations will certainly have kept some overseas investors on the sidelines.
Companies targeted by Mr Corbyn for a return to public ownership have been among the biggest climbers since election day. Energy provider SSE and water company Severn Trent, for example, have gained 11 per cent and 13 per cent respectively.
For bonds, however, the implications of a Corbyn government were always less clear. While bond investors might have balked at the idea of financing Labour’s enormous borrowing plans, the likely rush into safe assets would have been a countervailing force.
Hence the muted reaction to his defeat. Short-term gilt yields initially moved higher as investors priced out the chaos they assumed would accompany a hung parliament. But longer-term borrowing costs barely budged, largely ignoring a global sell-off in fixed income driven by optimism about a US-China trade deal.
The bond markets continue to bet against any post-election surge in economic activity. The Bank of England this week stuck to its forecast for a rebound in growth next year, but markets are pricing in a 50 per cent chance of a cut in interest rates next year.
Some analysts argue that this gloom among bond investors is misplaced. The Conservatives, too, have promised a big rise in spending, with Mr Johnson pledging billions of pounds for new infrastructure. If that effort provides an effective stimulus to the economy, helping to unlock private investment, the BoE may end up raising rather than cutting rates next year.
“There’s a big fiscal boost coming down the pipeline, and I think the bond market is underestimating it,” said David Owen, chief European economist at Jefferies. “The more loosening in fiscal policy you see, the more likely the BoE will have to tighten.”
In that sense, the post-Brexit UK is set to become a test case for a debate currently gripping global policymakers: whether fiscal policy can be more successful in stimulating growth than monetary policy has been.
If the economy picks up despite the lingering uncertainties of Brexit, bond and currency investors will be due a rethink.