The Weekly - The End of the Beginning

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14/01/2019
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So here we are after 2 years, 6 months and 21 days.  Parliament will decide what direction our country takes on the first step to leaving the European Union.  It could all be over immediately with objecting and noisy MPs capitulating and deciding that the deal on the table is better than no deal or no Brexit, or even a Corbyn government.  Alternatively, and the more likely scenario, is that the deal fails but if the margin is small, then that could well be an outcome that Theresa May and the EU can work with.  We would like to think there is a Plan B which looks like Plan A but with some sort of legal framework regarding the Irish backstop.  We have always been of the view, formed as soon as this deal was announced, that the backstop rules were probably going to be viewed as an unacceptable loss of control over our future sovereignty should we fail to agree a trade deal with the EU.  This hasn’t been helped recently by the Irish Prime Minister saying that he viewed this as the final deal outcome.

Winston Churchill once said that ‘democracy is the worst form of Government except all those other forms that have been tried from time to time’.  It is easy to look back in retrospect but if we hadn’t lost a majority ruling government and if we had had a Brexit supporting Prime Minister, then maybe we wouldn’t be in this democratic mess where there are around eight different reasons why MPs are voting for or against this deal.  This is actually quite representative of the electorate when the Brexit vote took place, and this is possibly why the original vote should have had a higher threshold to carry such as 70% as some have suggested.  No Brexiteer would support that view but the journey to this constitutional crisis has been a lesson for us all.
 
The markets and Sterling will have priced in the view from the City which will be rational, unlike the media and Westminster where hysteria and egos rule.  It would appear there is little appetite for ‘no deal’ either in the UK or the EU.  This is probably why Theresa May and the Cabinet are saying that if the deal fails in Parliament then the default is ‘no deal’.  This should make the EU sit up and reconsider their non-negotiating stance that they have steadfastly stuck to.  There is always room for manoeuvre as we have recently seen regarding the Italian budget where the newly elected populist, anti-EU government originally tabled a high spending deficit budget.  In the end it appeared that the EU was quite flexible and still allowed the Italian government to run a lesser deficit budget rather than simply sticking to the original Maastricht rules, which have been breached for many years.
 
Clearly the EU and the UK cannot push this out to the night before 29th March, as has been done previously with Greece when there was an impasse.  However, this week, and most likely the three days following this vote are our equivalent for deciding whether this deal, or something like it, is going to survive or fail.  If we get to the end of the week and Plan A and a Plan B have failed, then our view is that there are two options following that.  The first of these is to extend the leaving date - to do anything else would be irresponsible for the ruling UK government and the EU.  The hard Brexiteers could declare this goes against what the people voted for.. It is usual practice that if you can’t agree a deal in the time that has been allotted, then you apply for more time (so long as all parties agree) – this is also part of Article 50.  However, this weakens the EU’s position as by agreeing to an extension they are also agreeing to renegotiate, otherwise, there is no point.
 
Perhaps this is why Theresa May looks relatively calm and not like a Prime Minister on the edge, out of options and fighting for her survival.  On the last point she is safe having survived a vote of no confidence.  The Tories would also probably survive a vote of no confidence as the DUP are unlikely to vote to lose their power, which is pivotal to the whole issue of the backstop.  If a cross-party group takes over the negotiations, which possibly should have happened in the first place, then perhaps, with an extension of the leave date, we may get to a deal without all the partisan electioneering and public squabbling.
 
This feels like a dream from sunny uplands and a Brexit-free investment environment.  It would certainly lead to a psychological lift for the economy and the consumer, both of which have been remarkably resilient given all the negativity and gloom.  
 
Coming back to the markets, which are a short-term voting machine, we would like to think that common sense will prevail.  The rational assumption is that a lookalike Plan B deal, with a possible extension to the date of leaving to negotiate it, will prevail.  A second referendum or a ‘no deal’ outcome would appear to have insufficient support within Parliament.  The former would be undemocratic and will not happen whilst Theresa May remains in power which looks likely to continue to be the case.  The latter is probably a step too far for any politician both in the UK and the EU and will cause short-term economic chaos which nobody wants.  The likes of Macron and Merkel can ill afford economic disruption in their weakened positions.
 
You never know, we may just be approaching some sort of resolution that provides some desperately needed clarity.  The self-inflicted disaster route is obvious for all to see and something has to give to avoid absolute chaos.  Keep calm, hold your breath and look forward to Friday by which time we should have some idea of where we are headed.  At the very least, on a positive note, we are very close to the end of the beginning which means the end of the end must also be that much closer.

 

Equities rise on US-China trade talks

Global equities enjoyed a modest rally last week as talks in Beijing between the US and China reportedly made progress. In addition, the latest Federal Reserve minutes suggested a more patient approach towards further rate rises. The American S&P 500 climbed +2.5% whilst the FTSE 100 index closed the week +1.2% higher.

The US-China trade tariff spat has been weighing on markets for some time, but progress was reported on a number of issues and further talks are scheduled in Washington later this month.  Meanwhile, minutes of the December policy meeting at the US Federal Reserve revealed that many of the committee felt the Bank could afford to be patient about further tightening. The likelihood of another rate rise in the first half of 2019 now seems low. Powell expressed concern over slowing global growth but says he sees inflation holding steady close to the Fed's 2% target.  The yield on the US 10-year Treasury note rose four basis points to 2.69%.

In Europe, Germany’s DAX 30 added +1.1% and the French CAC 40 rose +0.9% over the course of the week. However, Economic concerns increased as industrial production in Germany and France fell sharply in November, down -1.9% and -2.1% respectively. Italy and Spain also saw output decline and this data is likely to support the view that the European Central Bank is unlikely to raise interest rates this year, despite ending its asset purchase program in December. Much like in the US and the UK, the Eurozone labour market appears to be an area of strength – the unemployment rate falling to its lowest level since the Financial Crisis at 7.9%.

US Government partial shutdowns are not uncommon in recent years, but with the stand-off now entering a fourth week and seemingly no end in sight, this is a situation that is moving into unchartered territory.  History would suggest the economic impact is usually limited but this may change the longer it drags on as disruption hits tax refunds and programs such as housing assistance for low-income families.

Most commodity markets rose despite reports suggesting China will soon lower its economic growth target by 50 basis points.  The price of a barrel of Brent crude oil rose +5.6% to $60.70 following the suggestion of further Saudi supply cuts.


Sources: Datastream, Forex Factory

 

The Week Ahead


Domestic focus will be firmly on Parliament tomorrow as it gathers for its long-awaited vote on the Prime Ministers proposed Brexit deal. Expectations are for it to be rejected; Labour are set to vote against it and its leader Jeremy Corbyn has suggested he will seek to trigger a general election as soon as possible. In terms of data, Wednesday’s CPI inflation number is forecast to show a slight reduction from the 2.3% reported last time with Friday’s ONS retail sales figures certainly worth keeping an eye on. After a busy first two weeks of 2019, US activity is in short supply with Friday’s industrial production and UoM Consumer Sentiment indicator the only figures of note. On Wednesday, the Federal Reserve releases its bi-monthly ‘Beige Book’ which will provide detailed analysis of the economy over the last 6 or so weeks. In China, the latest trade data has already been released this morning and if you’re the US President, it doesn’t make for pleasant reading. The country’s surplus with the US hit a record $323.0bn for 2018, +17.0% higher than 2017 as exports continued to surge. Trade numbers are also due from the Eurozone this week, as is CPI inflation which arrives on Thursday. There are no major releases from Japan on this occasion.

Sources: Forex Factory, CNBC