The Week Ahead: What next for Brexit and UK asset prices?
This is a critical week for the UK’s Brexit negotiations, after the UK Parliament voted to reject Theresa May’s Brexit deal for the third time on Friday, if Parliament cannot agree a way out of this crisis then the options to avoid a no-deal Brexit start to slim. It’s hard to believe, but this week could be even crazier for the pound and UK asset prices than last week.
So, what will happen next?
Below we take a look at a number of scenarios that could pan out over the next five trading days and assess what they mean for the pound and UK stocks. Uncertainty and high levels of confusion surrounding the Brexit process need not be bad news for traders, it levels the playing field so the smallest retail trader has the same chance of calling the next move in the pound, or the result of the next vote in Parliament, as the hedge fund manager with a team of 20 analysts. Exciting times indeed.
Before we start, here is a brief overview of how UK markets have performed in recent days. The pound plunged on Friday, with GBP/USD dipping below $1.30 at one stage, although it managed to close the week back above this crucial level, at $1.3028. This is significant as it suggests that pound buyers see this Brexit mess getting cleared up, but will this optimism last another week? The FTSE 100 was a different story, the plunge in global bond yields helped the UK index to finish Q1 on a high note, eradicating most of the late March losses. The weak pound/ strong FTSE 100 relationship has not been as strong this year, thus don’t bank on a strong FTSE 100 if the pound declines and vice versa.
What we can expect next week:
1, MPs take control of Parliament once again, more indicative votes
On Monday, MPs will have the chance to vote on alternative options to Mrs May’s Brexit deal. This is the second round of “indicative votes” held by MPs and gives them another chance to choose a new path for the Brexit process after all motions failed last Wednesday. Things could be different this week as momentum is growing behind a proposal to keep the UK within the Customs Union and Single Market. If this alternative option can get over the line, then a few things may happen:
· Mrs May chooses to tack the winning plan to her deal to get it passed by Parliament.
· A longer Brexit delay is then requested to renegotiate a Brexit deal 2.0 with the European Union.
· Theresa May sacrifices the hardliner Brexiteers in her party, and cabinet, to side with MPs, facing a raft of resignations and outrage among the leavers.
Or:
· If she cannot accept what Parliament wants, then the odds of a General Election start to shorten considerably.
The market reaction: while a vote in favour of the UK remaining in the Customs Union and the Single Market would be initially good news for the pound, potentially causing a 100 pip + rise, the reality of us remaining in both the Customs Union and Single Market without a General Election to affirm the decision is slim. Thus, the fact that this outcome could lead to a General Election at a crucial point in the Brexit process, is pound negative in our view. Eventually we would expect the pound to sink, if a General Election starts to look likely.
2, 4th Meaningful Vote on Theresa May’s original deal
If there is no breakthrough with MPs indicative votes then we believe another Meaningful vote, or MV4, is likely this week. Doing the same thing over and over and expecting to get a different outcome is one sign of madness, but it’s pretty standard stuff when it comes to the EU (think Ireland and the Lisbon Treaty, Greece and its vote on its bailout deal). Thus, a fourth vote cannot be ruled out, especially since significantly more Conservatives voted for the deal, including some prominent Brexiteers (here’s looking at you Boris and Jacob), last Friday.
However, this surely has to be the last time Parliament can vote on this deal, and if it fails to win the support of the House, yet again, then surely a no-deal Brexit is the only outcome, as precious negotiating time will have been wasted. We believe that if MV4 is called this week then the pound could be jittery in the lead up, with UK stocks and the UK currency potentially falling in unison. If the deal fails again, then we would expect to see GBP/USD dip below $1.30, as the FX market starts to panic that the UK will crash out of the EU without a deal on 12th April.
3, General Election
We mention above the risk of a general election on the back of the indicative votes on Monday, we think that the risks of another election being called is much higher this week than at any other time since 2017. If this happens the markets will want to know a couple of things: how long until the election? Will Brexit be stalled until after the election, what will be the status of the UK in the EU since the election is likely to come after the 12thApril Brexit deadline? Who will lead the Conservative Party if an election is called?
We believe that the odds are shortening for a general election because if Mrs May can’t get her deal to pass in the House, then her best option is to change the house. She may also be banking on voter fatigue, with the UK public choosing MPs who will vote in favour of her deal and oust the current MPs who are thwarting her Brexit ambitions.
This is a risky strategy, especially after what happened in 2017, and it would be pound negative in our view, as it increases uncertainty. It may also thwart the recovery for the UK 350, which is sensitive to the UK domestic outlook. If the polls started to show a surge in support for the left-leaning Labour Party, then the FTSE 100 is also likely to react negatively as fears about tax rises and a less friendly business environment start to bite.
4, Another Referendum
Theresa May continues to rule this out, but could it be another way for her to break the impasse in Parliament, without the risk of a General Election? This would likely be a pound positive development, as it increases the chance that Brexit could be scrapped altogether. However, we don’t believe that another referendum will be called this week, things may have to get much worse for this option to come onto the table.
5, No Deal Brexit
Even though this is a crucial week for the UK and UK asset prices, we do not believe that a no-deal Brexit is likely. The EU has already pencilled in another leaders’ summit for 10thApril, most likely so that they can agree to another extension for the UK passed the April 12thdeadline, and we do not believe that the EU will want to push the UK into a no-deal Brexit.
This view is important to our belief that even if the pound drops this week it will not fall precipitously, and we don’t expect GBP/USD to fall past $1.27 in the coming days. Likewise, stocks will also be protected from the ravages of a no-deal Brexit, especially the FTSE 350, at least for now, as we believe that the UK still has options to avoid a no-deal situation.
Global Markets Overview
Elsewhere, it is worth remembering that the S&P 500 had its best Q1 performance since 1998. Last week’s sharp fall in bond yields helped US and global stock indices to stage a recovery and recoup some losses from earlier in the month. The main event in March, was confirmation of the Fed’s policy U-turn, and a rising expectation that the next move from the Fed could be a rate cut, this was closely followed by the drop into negative territory for German bond yields.
The movement in global bond yields has a big implication for GBP/USD. Those looking for the pound to stage a recovery on the back of the inversion of the US yield curve were mistaken. Falling bond yields is a global phenomenon right now, which has eased the selling pressure on the dollar in recent weeks. This has thwarted GBP/USD upside. However, this development in the FX space doesn’t seem to be worrying speculative large investors, and according to the CFTC, speculative investors cut their short GBP/USD positions further last week to a mere -8.6k, down from -13.6k the week prior. This suggests fatigue with pound selling, and potentially a very optimistic hedge fund community looking for a deal to emerge before the final whistle on the UK’s EU membership blows.