This month’s UK general election result was an unmitigated disaster for the Conservative party. Indeed, it is hard to envisage a messier outcome. Weak and wobbly is the new strong and stable.
Having failed miserably to deliver her campaign soundbite, Theresa May would typically have been expected to resign, as her predecessor, David Cameron, did after his unsuccessful attempt to secure a Remain victory in last year’s EU referendum. However, May has displayed the tenacity of a pitbull in holding on to the keys of number 10 Downing Street, and her backbenchers, well-known for their ruthlessness in getting rid of ineffective party leaders, have been held in abeyance because of their fear that a Conservative leadership contest would have delayed the start of the Brexit negotiations, which they see as under continued threat from so-called Remoaners.
The Brexit talks have now begun. But it is clear the UK government is not negotiating from a position of strength, as it hoped or envisaged, but from a position of weakness. May has done what she can to try and shore-up her position. Most significantly she has cancelled the 2018 Queen’s speech and announced a two-year rather than the typical one-year parliament, thereby removing a potential opportunity for the opposition parties to hold an implicit no-confidence vote in her leadership. However, EU politicians understand all too well that May’s position is vulnerable – in fact, it looks wobblier with each passing day – and they will use this to their advantage in the Brexit discussions scheduled to take place over the next two years. Indeed, they are already doing so. On day one of the talks, the EU got the UK government to agree to discuss the issue of an exit fee before initiating any discussions on future trading arrangements, something David Davis, the UK’s Brexit Secretary, wanted to run in parallel.
A direct consequence of the election outcome is that May is now beholden to the support – a “confidence and supply” arrangement rather than a formal coalition – of the 10 DUP MPs in order to pass legislation. This will be a difficult relationship to manage. While the DUP supports Brexit, their manifesto did not propose leaving the single market and, crucially for them, they wish to see a soft Irish border maintained. Securing an agreement that will both appease the DUP and the Eurosceptic wing of the Conservative Party will be extremely difficult to achieve, especially from an EU negotiating team emboldened by the messy UK election result. And, with a wafer-thin working majority in parliament it would not take much for May’s government to find itself in serious trouble.
Compounding May’s problems, the public’s perception of her government has deteriorated markedly since the general election. Government anger sentiment has surged in the UK (see exhibit below) and currently stands at its highest level since the street riots in London during the summer of 2011. Such negativity is being reflected in the opinion polls, with Labour ahead of the Tories by three percentage points. This response has galvanized Corbyn and his acolytes to push for a second general election, thereby turning what was, in their view, a “virtual” election victory into reality. Given the fragility of Conservative minority government and the darkening social mood towards the government, a second UK general election within the next 12 months cannot be entirely ruled out, even if it appears not to be in the best interests of either Theresa May or the DUP. Accidents, in politics as in life, can and do happen!
Exhibit 1: Crowd-sourced Government Anger Sentiment – UK
Despite the increased political uncertainty generated by the messy election result, some commentators have argued that the prospect of a softer Brexit – the result of necessary compromises the Conservatives must make in order to stay in government (if not in power) – means that the implication for GBP is more nuanced, especially in light of the less dovish stance of the MPC at its last policy meeting. (A perception reinforced by comments made on June 21 by BoE chief economist, Haldane, but apparently not shared by his boss if his Mansion House speech is anything to go by). Such arguments sound plausible, but when we observe how crowd views towards the UK currency have evolved since the election, it is hard to detect the influence of such arguments. In fact, since June 8 of all developed currencies we track, GBP sentiment has fallen the most – see exhibit below – having declined by -0.64 (reading shown on the outer ring).
Exhibit 2: Crowd-sourced Sentiment – Developed Currencies
In light of all of this negativity, some investors could be tempted to conclude that the downside for GBP is fully priced. We would respectfully disagree. Although GBP sentiment has fallen sharply since the June 8 vote, the decline has only unwound the crowd’s earlier bullishness such that in level terms GBP sentiment stands close to its long-run average and is best considered neutral – see exhibit below. Certainly, it is far from the extremely negative readings witnessed last summer after the Brexit vote and which, as we noted at the time, suggested GBP was ripe for a (contrarian) rebound.
Exhibit 3: Crowd-sourced Sentiment – GBP
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Given the unstable nature of UK domestic politics, the potential for the Brexit talks to generate negative headlines (which is all part of any negotiating process where brinksmanship tactics are being used e.g. “no deal is better than a bad deal”, “I’m not in a frame of mind to make concessions”), a clouding of the UK economic outlook tempering any nascent BoE hawkishness, there appears plenty of scope for the crowd to become more bearish on GBP.
Obviously, currencies are a zero sum game and exchange rates are relative prices, so GBP weakness necessarily implies another currency appreciates, but which developed currencies are best positioned to benefit from ongoing GBP weakness.
Referring back to exhibit 2 above, the two developed currencies where crowd sentiment has increased most since the UK election are the CHF followed by the USD. However, just as with GBP, one needs to consider the momentum of sentiment together with the level of sentiment in order to assess more fully a currencies prospects. In both cases, the recent rise in crowd positivity towards the Swiss and US currencies has pushed crowd sentiment to historically elevated levels. This is a warning that there is limited emotional “fuel” to drive these currencies higher.
A more fruitful candidate worth considering is the AUD – a currency where crowd sentiment has experienced positive momentum but where in level terms sentiment is still in negative territory, and hence less encumbered by the weight of positivity (i.e. there is greater scope for the crowd to become more constructive).
That said, while we were taking an in-depth look at crowd sentiment in currencies in preparation for this Market Insight, we noticed something peculiar in relation to the USD. Take a look at the following exhibit, which compares sentiment by media type and you will quickly see to what we are referring.
Exhibit 4: Crowd-sourced Sentiment By Media Type – USD
Social media is extremely, and increasingly, positive towards the USD whereas mainstream media is more modestly, but increasingly, negative. Hence, while aggregate crowd sentiment towards the greenback is elevated by historic standards it masks a degree of divergence in tone between the two media types that is unprecedented in the 11-year history of the series. The USD, it would appear, is suffering from bipolar disorder.
All a first for the currency, it is not the first time we have witnessed such strong divergence in the crowd’s opinion towards US asset prices dependent upon the media type. As our regular readers will recall we noticed something similar in the US equity market earlier this year. Several weeks back this gap in emotional tone between the two media types was narrowing, but this recoupling has ceased and is once more diverging.
When we examine crowd sentiment towards the US economy we get a clear sense as to what is driving this sentiment wedge between the two media types. In short, social media is much more positive about the US economic growth outlook than mainstream media.
Exhibit 5: Crowd-sourced Sentiment By Media Type – US Growth
As is well recognized, US macroeconomic data have hardly been signaling very robust growth over the past several months. Unquestionably, this has dampened animal spirits amongst professional investors, who opinions we consider more in keeping with the tone of mainstream media. By contrast, the animal spirits of retail investors, whose opinions we believe are better reflected in social media, have remained ebullient.
No one knows for sure whether the optimists or the pessimists will be proved right (we are still siding with the optimists for the reasons we outlined in a recent Market Insight) but what we can be sure of is there is plenty of “emotional” fuel for US asset markets to move as and when this sentiment divergence is resolved.
 Watch out Larry (a veiled reference to our last Market Insight – see: https://amareos.com/financialresearch/the-market-sentimentalist-who-will-be-larrys-new-minder/
 Her distant response to the tragic Grenfell fire did nothing to dispel such speculation.
 Despite the Northern Irish electorate having voted in favour of Remain (56% versus 44%), this is one of their less contentious policy positions. Some wags have described their manifesto as the Old Testament with fortnightly rubbish collection.
 Quotes attributed to various members of the UK government and Michel Barnier, the EU’s chief negotiator, respectively.
 The second ring from the centre refers to the level of sentiment and is colour coded on the sae basis of the heat maps we often refer to in our Market Insights. For a recent example of these heat maps – see: https://amareos.com/financialresearch/market-sentimentalist-whos-eating-porridge/