FTSE: UK election uncertainty adding insult to injury for stocks, bonds

May 7, 2015

The global stock and bond market rout is continuing for another day and no one is quite sure why these assets are being hammered in unison. After all, if it was worries about the health of the global economy one would have thought that the safe haven bonds would have performed better. But German bunds have now fallen for an eight consecutive day; the French 10-year bond yield has risen above 1% for the first time since early December and in the US the equivalent yield is hovering around 2.25 per cent. To some degree, the behaviour of the US bond and equity markets makes sense as investors withdraw from these QE-propelled assets now that the Fed’s asset purchases programme has ended and are debating on the timing of the first rate hike there. The European bond market sell-off may be explained away by the rallying euro. Up until a few weeks ago, the euro was seen as a funding currency thanks to the recent introduction of QE and negative interest rates from the ECB. Speculators were borrowing euros for cheap to buy European stocks and bonds. But this trend has come to an abrupt halt. The EUR/USD, for example, has been underpinned by some disappointing US economic data of late; EUR/GBP by the UK political uncertainty and the EUR/NZD by a dovish RBNZ. As a result of the firmer euro, European stocks and bonds have both been hammered. One other source of support for bond yields has been the rebounding oil prices of late which have reduced deflationary risks and thus the need to hold onto safe haven government debt.  Stocks meanwhile have also been hurt by continued uncertainty about Greece, economic slowdown in the US and China, and the political situation in the UK, among other sentiment-sapping reasons.

But things could change very rapidly, for at least some of the bad news is surely now priced in. What’s more, the ECB is unlikely to halt its bond purchases programme early because the economic outlook in the euro zone remains uncertain; this may support stocks in the long term.  Indeed, nearly all of today’s earlier euro zone data releases failed to meet the expectations with the German factory orders, for example, increasing only 0.9% month-over-month in March when a rise of 1.6% was expected. On top of this, industrial production in France fell by 0.3% and its trade deficit widened to 4.6 billion euros. The latest euro zone retail PMI did however top expectations as it rose to 49.5 in April from 48.6 previously, albeit it still remained in the contractionary threshold of below 50. The main data release from the US today is the usual weekly jobless claims figure, due out at 13:30 BST. Last week saw claims for unemployment benefits fall to a 15-year low of 262,000 applications. A number close to this one this time would bode well for the official jobs report on Friday.

But for now, the path of least resistance for equities in general is to the downside and will remain that way until proven wrong. The UK’s FTSE remains under increased pressure because this is one of the most unpredictable elections in history. The biggest risk for the FTSE could be if we get a hung parliament. Even if this potential outcome has no economic impact, the uncertainty that comes with it may well undermine the appetite for risk. That said, the index is comprised mainly of large multinational corporations and as such the outcome of the election may not have a lasting impact on the FTSE, though certain stocks or sectors could be affected nonetheless. Once the elections are out of the way, and depending on its outcome, investors may decide it is time to pile back into the UK stock market. But they may still hold off a little bit longer until at least when the global stock markets have found a firm footing.

As always, the near-term downward trend is more likely to end near key support areas because speculators often get in and out of positions around such technical levels. An equally important point to remember here is that a breakdown of a key support level often leads to further follow-up technical selling. So, for the FTSE, a confirmed daily closing break below a key level such as 6845, which corresponds with the bullish trend line, would be a bearish outcome while a reversal signal (such as a hammer or bullish engulfing candle) around here or another support level further lower would be deemed bullish.  Indeed, a decisive break below 6845 may pave the way for a move all the way down to 6720 – the 200-day moving average converges with the 38.2% Fibonacci retracement level here – or the prior low at 6670, before making its next move.  Meanwhile some of the resistance levels to watch going forward are those that were formerly support, such as 6900. 

Figure 1:

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