Another June Shocker From The U.K.

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Includes: DRR, ERO, EUFX, EUO, FXE, UDN, ULE, URR, USDU, UUP
by: Andrew Hecht

Summary

Brexit was a shocker.

The June 8 election results were not what the market expected.

France was different because of the candidate.

Faith in the status quo continues to decline.

A message for currency markets and leaders around the world.

I spent my last year of college living in London and was lucky enough to receive an assignment from one of the world's leading commodities trading companies to live in the city from the late 80s through the early 90s. London is a fascinating international city and, unlike New York City, where I spent most of my life, London has been a center of commerce for many centuries. The British, and Londoners, are rare breeds who are proud of their history. I will never forget my ride home to St. John's Wood from Victoria Station each night in a taxi where I would pass a house with a plaque that read "Home of Benedict Arnold - A Great British Patriot." As a student of American history, I would snicker as the first leaders of the U.S. hung Arnold as a traitor. Two hundred and thirty-seven years later that name is still synonymous with betrayal. In the financial markets, the British have a long history of market innovation and independence. It was those independent streaks that lead the nation to shock the world and vote to exit the European Union on June 28, 2016.

Brexit was a shocker

2016 was a year of political shocks, but the United Kingdom was the trendsetter. Before the Brexit vote, the pollsters confidently predicted that the measure would never pass and the U.K. would remain part of the European Union. On June 28 of last year, in a close election, the citizens of country handed the pollsters, the European Union, and the world a shock that reverberated around the globe when they voted to divorce Europe and reject globalism. The critical issue in the election was immigration policies when it came to the flood of immigrants coming into Europe from the Middle East and North Africa. The rise of terrorist incidents in Europe and increasing unemployment as a result of new arrivals on Europe's shores caused the British to reject immigration policies decided in Brussels. The weakening economies of Southern Europe that required bailouts from the ECB in Frankfurt contributed to the decision by a majority of U.K. citizens to divorce Europe and go it on their own. Source: CQG

As the weekly chart of the British pound versus the U.S. dollar shows, the shock of the results from the Brexit referendum sent the British currency from $1.50 against the dollar in June 2016 to lows of just above $1.20, a move of 20%. The initial shock took the pound down to under the $1.30 level in July as the Prime Minister, who had supported remaining within the European Union, resigned in the immediate wake of the vote. As the weekly chart highlights, the pound-dollar relationship put in a bearish key reversal following the surprise news that the U.K. would be filing for divorce from the E.U.

After the resignation of David Cameron as Prime Minister, Theresa May took over the position, and her popularity soared as the nation prepared to file the articles of divorce from the rest of Europe. Prime Minister May became so confident of her popularity that she decided to call for a snap election back in April of this year. The reasoning behind the move was to take advantage of her high status in the polls and to provide a mandate from the citizens of the United Kingdom as she prepared to go into battle negotiating terms of the Brexit from the Union. The snap election on June 8 did not turn out as she had hoped.

The June 8 election results were not what the market expected

Up until a few weeks before the election, Prime Minister May had a comfortable 20 point lead in the polls over Labour Party leader Jeremy Corbyn. Many wrote off Corbyn as a left-wing candidate on the fringe of the Labour Party with little support from even within his ranks. However, two terrorist attacks in the nation in the weeks leading up to the snap election and a poorly managed campaign by an over-confident Prime Minister resulted in another June shocker in the United Kingdom. The Tory Party, led by the Prime Minister, lost their majority position in Parliament in the June 8 contest and had to form an alliance with the Democratic Unionist Party to maintain control. Last weekend, Labour Party leader (and perhaps many within the Tory Party) called for the ouster of Prime Minister May and her days may very well be numbered as the leader of the nation.

The election results in the U.K. last week were a continuation of a trend the nation started last year with the Brexit vote. It turned out that Jeremy Corbyn received lots of support from young voters in the country and his success in the election has made him a British Bernie Sanders who almost knocked off Hillary Clinton in the Democratic primaries in the United States last year.

The election results could spell trouble for the U.K. economy, and the pound fell in the aftermath of last week's election. Source: CQG

As the weekly chart illustrates, the pound put in another bearish key reversal trading pattern against the dollar last week and momentum on the pound has shifted to the downside. We could be in for a new low for the British currency in the weeks and months ahead.

One of the reasons for the shock in the British election was that in recent European elections, the status quo had prevailed. After getting it right in the Netherlands and France, the pollsters suffered another setback last week in the United Kingdom.

France was different because of the candidate

The Brexit vote was a shock because pollsters did not expect the nation to vote to leave the E.U. Then, in the U.S. election, the polls once again read the tea leaves dead wrong as the nation elected Donald Trump as the forty-fifth President. The favorite, Hillary Clinton, went down in defeat as a populist and nationalistic wave swept across the U.S. President Trump campaigned to Make America Great Again and put the nation first when dealing with other countries around the world. His message resonated with voters and continued the trend that began in the U.K. where voters rejected globalism and the loose immigration policies of the European Union.

Earlier this year, the status quo candidate in the Netherlands prevailed as pollsters had predicted. The country is small, and the right-wing candidate was too controversial for the populous that decided that the status quo was better than the other option. The same thing happened in France in early May.

The recent election in France came down to a run-off between Emmanuel Macron, a pro-E.U. candidate and Marine LePen, the nationalist choice. The two potential leaders faced off after receiving the most support in the first round of voting. While Macron is an outsider to politics and the youngest leader of the nation since Napoleon, LePen had too much baggage, and he beat her in the election like a drum. Marine LePen's father has been a right-wing fixture in French politics for decades, and many of his past statements worked against her chances of becoming the leader of the nation. In the final election, she received only one-third of the vote while Macron defeated her in a landslide. It was likely not the message she carried to French voters, but her baggage and any other nationalist and populist candidate would have fared much better in the election given the current sentiment in Europe and around the world when it comes to electing political leaders. Last week's British election resumed the political trend of 2016, and the French election could have just been a blip due to a candidate that many in the nation could not stomach.

Faith in the status quo continues to decline

Faith in the status quo amongst voters around the world has been on the decline, and they have been handing pollsters a series of surprise election results since 2016. The latest shock came last week in the United Kingdom, and there are likely more to follow.

In the aftermath of the French election, German Chancellor Angela Merkel who is a pro-European Union and globalist candidate for office must have been feeling pretty good about her chances for a fourth term when the Germans go to the voting booths this September. However, the Tory Party hammering in the U.K. has to have her thinking twice these days. Europe continues to be a hotbed of political and economic problems. While the European economy has improved, partially because of the decline in the euro currency in 2016, last week a Spanish bank, Banco Popular, became insolvent and was taken over by Bank Santander for the price of one euro. The Italian economy continues to teeter on the brink of economic disaster. At the same time, terrorist attacks in Manchester and London over recent weeks following other such deadly events in France, Belgium, and Germany are a constant reminder of the political threat that hangs over the continent. The vast immigration wave from the Middle East and North Africa over recent months and years allowed some unsavory characters to enter Europe. The voting populous is not likely to let current leaders like Chancellor Merkel off the hook if attacks continue or increase in numbers or casualties over the coming months in the lead-up to the German elections after the summer season. Faith in the status quo has declined in Europe and the U.K. election last week was another reminder of how wrong the polls can be and how a favorite candidate can slip from favor in the blink of an eye these days.

A message for currency markets and leaders around the world

The populist and nationalistic wave that swept across the U.K. and U.S. in 2016 is still alive and well. Next week it is possible that there will be a new Prime Minister at number ten Downing Street as the election results crippled the current leader of the nation. The pound is likely to sink to a new low as uncertainty of the Brexit negotiations now takes center stage with the British hobbling into the divorce court proceedings.

Markets have shrugged off a lot of signs over recent weeks and months when it comes to the global political and economic landscapes. North Korea continues to fire missiles in defiance of the U.S. and other world powers. The temperature rose in the Middle East last week as Saudi Arabia and its allies severed ties with Qatar accusing the richest nation in the region and fellow member of OPEC of funding terrorist groups and buddying up to the Iranian theocracy. Russia continues its expansionist path in Syria and the Middle East with its alliance with Iran, and China continues to build its military complex in the South China Sea. In the United States, the new President continues to be under siege from the opposition Party and the press. On the economic front, the global economy has improved over recent years, but growth is only moderate with lots of potential potholes along the way in the coming months.

The stock market in the U.S. and around the world continues to attract capital flows with the major averages making new highs over recent weeks. Last Friday, we saw what could be the beginning of as crack in the bull market as tech stocks suffered their worst session since May 17 when a one-day correction gave way to new highs in all of the major equity indices. At the same time, the price of gold had been moving higher as fear and uncertainty amongst some market participants has increased demand for the yellow metal. Last week, gold rose to almost $1300 per ounce before correcting lower as the dollar, which has been flirting with 2017 lows, recovered marginally at the end of the week. An interest rate hike by the U.S. Fed on Wednesday, June 14 caused further weakness in gold and some strength in the dollar, but the greenback remains a lot closer to support than resistance and is overdue for a technical bounce which could be bad news for the pound over coming sessions.

2016 taught us to expect the unexpected in elections and market. Last year was a year of surprises. 2017 started off with a couple of victories for the political status quo in Europe but the U.K. election last week should serve as a reminder to all market participants that the world continues to be a volatile place and markets are a reflection of the global landscape. Fasten your seatbelts we could be in for lots of volatility in markets across all asset classes.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.