Natixis Investment Managers: Brexit's deal - door Esty Dwek

17 oktober 2019

Market Flash – Draft Brexit Deal

What happened?

- Negotiators from the UK reached an agreement with European Union officials in Brussels that could pave the way for Britain to leave the European Union later this month after 46 years within the common bloc.

- This Withdrawal Agreement was completed just before EU leaders meet for their Summit today and tomorrow. European Commission President Jean-Claude Juncker called the deal “fair and balanced”.

- Mr. Johnson celebrated the “great new deal” and asked for Parliament to “get Brexit done on Saturday so we can move on to other priorities”.

- The EU has released a revised political declaration setting out the future relationship between the European Union and the United Kingdom, establishing the “parameters of an ambitious, broad, deep and flexible partnership across trade and economic cooperation with a comprehensive and balanced Free Trade Agreement at its core”.

- Under this Agreement, both Parties have agreed to develop a wide-ranging and balanced economic partnership, encompassing a Free Trade Agreement, as well as wider sectoral cooperation where there is a mutual interest. The economic partnership should therefore ensure no tariffs, fees, charges or quantitative restrictions across all sectors. Further provisions on free movement of capital and payments related to transactions liberalized under the economic partnership, subject to relevant exceptions, are also likely to be included. The principle of free movement of persons should not apply and the Parties should establish mobility arrangements: visa-free travel for short-term visits, conditions for entry and stay such as research, study and training.

- The question of the Irish backstop still appears to be an issue, as this deal would see Northern Ireland tied to both sides after Brexit. Northern Ireland would legally be in the UK customs union, but practically applying EU rules and procedures on tariffs, implying a border in the Irish Sea.

- The Northern Ireland’s Democratic Unionist Party (DUP) announced they were not happy with this version of the deal and will therefore not support it. In their opinion, while some progress has been made, the question of the Irish backstop has not been resolved to their satisfaction.

- Labour Leader Jeremy Corbyn called for a second referendum, saying that the deal was worse than the one proposed by Theresa May.

- Markets rallied on the initial announcement, before fading as the chances the deal gets approved in the UK decreased given the DUP’s objection.

What’s next?

- The Agreement will be reviewed and discussed during the EU Summit, but mostly, it still needs to be approved by the UK Parliament, which is holding an extraordinary session on Saturday.

- Since Mr. Johnson no longer has a majority in Parliament, and since he depends on his DUP coalition partner, this is still a big hurdle.

- Without his Northern Irish allies, Johnson needs to pick up roughly 61 votes of a pool of 75 available deputies to get the deal approved, which involves convincing deputies from his own party too.

- Mr. Johnson take this deal to a vote on Saturday even though the DUP has so far said it rejected it. He might be hoping they will change their mind, or realize the alternative is worse for them. Some hard Brexiteers in other parties could vote for this deal, giving Johnson the required votes, as they believe that a soft Brexit is better than no Brexit at all. He might also need to get some support from Labour, which could require him to attach a referendum (this deal vs Remain).

- If the deal gets approved in UK Parliament, the transition period would begin on 1 November and trade talks would start immediately as well. We believe that both would eventually be extended, so a virtual status quo would reign for more years, but without uncertainty. This would be accompanied by a strong market rally, with financials benefiting, especially as yields would rise as well, steepening the yield curve. Sterling would also continue its recent rise, breaking 1.30 against the dollar.

- The bigger question is what happens if the deal gets rejected. Mr. Johnson would push for general elections again, though this might require a second referendum. There is also the possibility of a caretaker government, which could also include a referendum ahead of elections. In any case, uncertainty would persist, and assets would retreat to recent levels.

- While it is difficult to speculate on political developments – especially in the UK – we believe that Mr. Johnson’s deal has a better chance of passing than Mrs. May’s, as there is much more Brexit fatigue, as uncertainty has been weighing on data and sentiment, and as this might be the last chance for a softer Brexit deal.

Investment implications

- Sterling rallied on the news, continuing its recent upward trend, with GBPUSD up more than 1% to 1.2990 in the minutes following the news, though it has since retreated as investors re-assess the likelihood of the deal passing Parliament. As we speak, sterling sits at 1.28, down 0.2% against the dollar.

- Sterling initially strengthened against the euro as well, but is now down by 0.6%. Interestingly, the bigger winner is the euro, up 0.4% against the dollar.

- Equity markets in Europe rallied cautiously. After the initial spike, most European equities indices have eased back. The FTSE 100 index is the biggest winner, up 0.9%, while US equity futures advanced by 0.2%. Financials benefitted the most, as rates backed up and Free Trade Agreement, encompassing free movement of capital and payments would support the sector.

- Sovereign bond yields retreated on improved risk appetite, with the 10-year Bund yield reaching -0.34% before retreating to -0.39%. The US 10-year yield is up as well to 1.75%.

- We maintain a constructive view on risk assets, as we believe that easing geopolitical tensions across both Brexit and US-China trade will support sentiment, and we do not believe that a no-deal is likely. Would could still see initial disappointment if the deal is not approved in the UK. And we believe that some decent earnings results in Q3 might be needed to extend the rally.

- While yields have backed up, we do not expect a sharp move either as long as inflation expectations remain muted and concerns about global growth persist, but yields could still drift higher if global uncertainties continue to be removed.