February 12, 2019
Peter Donisanu, Investment Strategy Analyst
Peter Wilson , Global Fixed Income Strategist
Brexit: No-deal Risks on the Rise
- Members of U.K. parliament (MPs) are back in the House of Commons this week to debate and vote on Prime Minister Theresa May’s Brexit deal.
- MPs are seemingly growing more deadlocked on a Brexit direction going forward, and we believe this increases the chances of the U.K. stumbling out of the EU without a transition plan in place.
What It May Mean for Investors
- While we do not expect a no-deal exit to take place in March, we believe that risks to the markets are growing at a time when growth in the eurozone is softening.
This week MPs in the House of Commons will once again consider Theresa May’s Brexit deal following her return from EU negotiations in Brussels. Little was expected to have changed with respect to content of the Withdrawal Agreement, which was first put to consideration at the end of last year. Expectations were set for MPs to vote on effectively the same deal, which they have already rejected, but with negotiations extended, such a vote is now not likely until late February or even March.
What is a no-deal Brexit and is it becoming more likely?
As a quick refresher, a no-deal Brexit could occur if a majority of MPs simply cannot decide on which direction to take with respect to honoring the outcome of the June 23, 2016 referendum. The issue at hand is that Theresa May’s government believes it has negotiated the best terms possible for the Withdrawal Agreement; yet, she cannot muster a majority of MPs to support it. A no-deal Brexit still seems unlikely as it is strongly unpopular among MPs. Yet, the Commons so far has failed to find an alternative, and the U.K. is running out of time to negotiate an exit by the March 29 deadline.
It is true that alternatives exist to a no-deal Brexit, such as approving Prime Minister May’s proposed deal, putting the issue to the people (another referendum), replacing the current government, calling general elections, or simply requesting a Brexit delay to the March 29 exit deadline. The trouble is that each of these options require a majority vote from parliament to pass. Yet, from the start of the year, MPs as a whole have demonstrated little conviction in one direction or another aside from their overall dislike for the deal up for debate this week.
This was evidenced in a Commons vote at the end of January on amendments to the Withdrawal Agreement. Of the various proposed amendments, the one that passed reinforced the current impasse: a Brexit deal without a backstop and a non-binding desire to avoid a no-deal Brexit. To put into context, other amendments had proposed the above alternatives, but none were able to muster a majority.
MPs were expected to debate Prime Minister May’s deal this week, followed by a vote on Thursday to approve or reject the deal. Latest reports suggest that, if there is no progress on renegotiation, Thursday’s debate will be another opportunity for MPs to suggest alternatives—but not necessarily with any greater likelihood of success than during the vote on January 29. The current expected timing of a new vote on the Prime Minister May’s deal is late February or early March. This narrower time frame and the potential for another rejection raises the risk of a no-deal exit, contributing to an environment unfavorable to risk assets—particularly at a time when economic growth in the eurozone has been deteriorating.
Indeed, a no-deal Brexit would likely cause much short-term disruption for member countries of the U.K. and eurozone. We believe that economic disruption would be severe in the near term. The indirect effects could also negatively impact business and consumer sentiment at a time when confidence in the currency bloc is waning. Coupled with a European Central Bank bias towards raising interest rates, we believe that a no-deal exit could exacerbate weakness in the eurozone economy and curtail investor’s preference for risk assets.
We believe there is still time for the U.K. to avoid a no-deal exit (our base case scenario), and developments in the House of Commons this week will likely give more perspective on the market and economic risk of a no-deal in the coming weeks. In the meantime, we suggest that investors refrain from overextending their exposure to European risk assets, where we maintain a neutral rating to the region’s stocks and an unfavorable rating on international developed market bonds. Both the euro and pound would be extremely vulnerable versus the dollar in the event of a no-deal Brexit. We prefer U.S. equities as well as emerging market equities and bonds (U.S. dollar-denominated) over those of Europe and other developed markets outside the U.S.
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