Turkeys avoid pre-Christmas vote

11 Dec 2018

John Wyn-Evans

Head of Investment Strategy, UK

Theresa May's decision to delay Parliament's vote on her Brexit deal sent the pound into a spiral and saw UK Gilt yields fall further 

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I sat down yesterday morning to write this week’s Weekly Digest with a view to running through various Brexit scenarios based on the fact that a parliamentary vote was going to take place tonight. So much for my plans.
News of an afternoon statement by the PM filtered out along with leaks that she was going to postpone the vote. Cue a sharp sell-off for the pound and risk assets exposed to the UK economy as the time-frame for any sort of resolution to Brexit was once again pushed out.
Earlier we also had confirmation that the UK is legally able to revoke Article 50 without the consent of the EU27. Ironically this ruling that allows for a degree of self-determination was delivered by the European Court of Justice.
So now all options are on the table, from a “no-deal” Brexit to no Brexit at all. This makes for an extremely complicated probability tree of outcomes. Based on what we know now (which could, admittedly, change before you even read this), what are the options?
The pound took another leg down following the speech, and UK Gilt yields also fell further. This reflects increasing uncertainty and possibly the increased likelihood of no deal. 
Having listened to Mrs May’s speech, it is clear that the fundamental sticking point for her proposed exit deal is the Irish border backstop, which seems to satisfy few MPs. Especially unhappy are those from the DUP who fear that they risk being effectively governed by the EU.
So, back to Brussels goes the PM to try and renegotiate elements of the border agreement, although it’s not clear what can be delivered. Even before Mrs May stood up, Ireland’s PM Leo Varadkar said that there was nothing else that could be offered, and various policymakers from the European Commission have echoed that view.
Somewhat predictably, Jeremy Corbyn has suggested that she should remove herself from the situation completely.  
The pound took another leg down following the speech, and UK Gilt yields also fell further. This reflects increasing uncertainty and possibly the increased likelihood of no deal. Mrs May has not offered a firm date for another parliamentary vote (although it looks like the end of January), and that leaves her increasingly vulnerable, both from Tories and from the opposition.
However, at this stage we would discount the immediate risk of a general election. The Fixed-term Parliaments Act of 2011 requires a two-thirds majority to unseat the government, and it seems improbable that even Mrs May’s most vocal opponents in her own party will be prepared to vote for their own possible demise. 
German Chancellor Angela Merkel walks with British Prime Minister Theresa May upon May's arrival for talks at the Chancellery on December 11, 2018 in Berlin, Germany

Theresa May went on a tour of European leaders, including German Chancellor Angela Merkel, in a bid to sweeten the Brexit deal

The three main outcomes that are left on the table are:
  1. Deal (on whatever the PM comes back with, if anything)
  2. No deal (which is the most disruptive economic outcome); and
  3. No Brexit (which could be the result of a further referendum, if offered. It is hard to see Parliament taking that course by itself).
The fact that there is no consensus in parliament means that the odds of another referendum have narrowed recently, although it comes with its own particular threat. However attractive a no-Brexit scenario might appear to the business community, there is no doubt that it risks undermining the democratic process, a view that has informed Mrs May’s approach from day one.
Leaving aside the moral arguments about who might have misled voters or benefitted from possibly illegal campaign funds, or the influence of Russian hackers, it is the impact on society that could be most serious.
With no consensus in parliament, the odds of another referendum have narrowed, although it comes with its own particular threat.
Although I am pretty sure that if Remain had won the Leave campaigners would not have let it lie (see Scotland for details), the Brexiters definitely feel that they won fair and square. Having that victory snatched away threatens an inflammatory reaction in what would become a highly polarised country.
I hesitate to say this, but it could create the circumstances for scenes in the UK such as we have seen in France for the past few weekends, especially in a world where certain politicians seem happy to legitimise such behavior. That is one reason why Mrs May is trying to force Parliament towards only two choices: her deal or no deal.
So we are not much wiser than we were yesterday morning, but definitely poorer.
There is still a massive gap, although now more balanced, between the extremes of possible outcomes, which can be seen in the market’s projections for the value of the pound.
A “no-deal”, with all the chaos that might surround it, offers 10-15% downside against the dollar (somewhat less against the euro which will suffer some collateral damage of its own) and no Brexit offers 10%-15% upside.
The irony of the latter outcome would be a projected fall in the value of sterling-based balanced portfolios as the translation of overseas profits of UK companies would be less attractive and non-sterling assets would be worth less in pounds.
Estimated fall in value of the pound, against the dollar, in a no-deal scenario
Estimated rise in value of the pound, against the dollar, if Brexit was cancelled
Also, Gilts would fall as the need for safe havens receded. This would be exactly the opposite of what happened in June 2016. However, more optimistically, it would potentially encourage investment and portfolio capital to flow back to the UK following all the uncertainty.
Right now there is little to suggest that Mrs May has done anything more than kick the can into 2019. But by pushing this vote to January, she is closing the window between the vote and the proposed date of departure, suggesting greater risk of a chaotic “no-deal” unless there is an extension to the leaving date.
If Mrs May has done this deliberately with the intention of forcing MPs to choose between her deal and no deal, then that is a high-risk strategy. Or maybe she is even steering Parliament towards another referendum without appearing to. I’m not discounting anything in the world of politics these days. 

About the author

John Wyn-Evans

John Wyn-Evans

Investment strategist

John is Head of Investment Strategy for Investec Wealth & Investment UK, is a member of the Global Investment Strategy Group, and is Chair of the Investec & Investment UK Asset Allocation Committee. John graduated from Exeter University in Modern Languages in 1984. He spent 27 years as an institutional stockbroker with Merrill Lynch and Lehman Brothers, before moving to investment management in 2011 and joining Investec in 2013. John is an Everton FC supporter.

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