Notes From Underground: With three unattractive candidates you need a “hung” parliament

Today we will have to deal with the European contagion, but first we report that the British election cycle is in full bloom as the second televised debate took place last night. These debates are a new format for the British electorate and they are have been well received by the voting public. Until the beginning of the recent campaigning, the Tories, with party head David Cameron, were a heavy favorite as the British electorate have seemed to grow weary of 15 years of Labor Party rule. Gordon Brown, the current prime minister, is still trailing Cameron, but Nick Clegg, the Liberal Democrat candidate, has surged in the polls following a grand performance in the first debate. Polls released after tonight’s debate recorded that none of the candidates really changed their numbers, so the prevalent view is that Britain will have a HUNG PARLIAMENT.

For those unfamiliar with parliamentary forms of government, it means that if no one has an outright majority two or all of the parties will have to form a coalition in order for the Parliament to reconvene. This means that there has to be a great deal of compromise on key issues to enable the parties to coalesce. What happens is that cabinet positions are divided and the policies become less strident. We believe that this is not a bad thing. The market also seems to be coming around to the view, as the British Pound has been gaining ground against a wide range of currencies. The most dynamic moves for the POUND has been against the EURO, as Britain is now a credible investment alternative to the beleaguered EURO.

We have written for awhile that the depreciation of the POUND during the past eighteen months made British assets very cheap for foreigners. When Lehman imploded, the EURO/STERLING cross was trading in the mid-70s, and, as the credit crisis deepened, the cross ran up to 98, a depreciation of almost 25%. If you mark the cross from the beginning of the credit crisis in 2007, the POUND’s depreciation against the EURO and other currencies was almost 50%. We reiterate this point to show the benefits of a floating currency acting as a ballast to help right the ship in turbulent times. Britain’s advantage over the PIIGS was/is that the currency depreciation helped to sustain Britain’s tradable goods at a time that domestic demand was eroding–no small event. While the PIIGS remain strapped to the mast of the German economy, depreciation is not possible and this is ultimately the problem. The Brits have stayed out of the currency union and we hope that the three unattractive candidates maintain that course no matter how hung parliament. We advise looking at your technicals and measuring the probabilities and patterns of the British POUND remaining an attractive investment location versus other venues (think of Kraft buying Cadbury).

In Europe today, the contagion of Greek default spread like the Black Plague. Portuguese 2-year rates jumped 52 basis points (bps), while 10-year rates were up 19 bps. Irish yields popped 53 bps on the 2-year and 17 bps on the 10s. Spain and Italy were both up but not as dramatically. The Greek situation was horrendous as 2-year Greek debt was priced at 10.22%, a rise of 244 bps, while the 10-year note soared 75bps to 8.84%. As should be expected, German rates dropped. The situation has entered crisis point and the ECB/IMF plan of action is going to be tested. Talk is over. The market awaits real action or as the Chicago crowd says, “Money Talks and B.S. Walks.” The silence is deafening.

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