Brexit: Daily update

What’s important?
The UK held a general election on Thursday, the third election since 2015. With a comfortable majority won by the Conservatives, the United Kingdom is now on course to leave the European Union on January 31 2020.

What’s new?
46 million voters were invited to choose an MP for their area – one of 650 constituencies. With 358 seats won (the best result for Tories since Margaret Thatcher and 40 more than at the 2017 election), the Conservatives were the big winners. Boris Johnson is now going to visit Buckingham Palace to ask the Queen for permission to form a new government… and become Prime Minister again! Labour got 203 MPs elected, a significant decline from its 262 MPs after the 2017 election. The Scottish National Party – which said a strong vote for them would effectively be a mandate for a second independence referendum – got 48 seats, a significant gain from the previous 35 seats.

What's next?

The Conservative party’s majority will allow PM Johnson to lead the country out of the EU (the UK joined in 1973): the withdrawal agreement is going to be approved by the UK Parliament and the U.K. will leave the EU by end of January 2020. Brexit will however be not yet done as PM Johnson will then have to negotiate the future relationship between the UK and the EU. While he promises to get this done before by the end of 2020, the EU has already said it is going to be very difficult to settle all the details of the trade agreement in such a short time. In the environment, uncertainty is likely to continue to weigh on UK growth next year as companies continue to postpone their investment and hiring decisions as long as it remains unclear about the future UK/EU relationship. Fiscal policy should however help the UK economy to regain some momentum: if the Conservative party follows its manifesto, fiscal policy will add 0.4 to 0.5% to UK growth next year, allowing growth to accelerate to around 1.5% in 2020 (from slightly above 1% in 2019). Most of the boost will come through more public investment (and possibly some increase in education outlays), but not through an increase in day-to-day public spending. As Conservatives have pledged not to increase the main tax rates, the public deficit will rise from slightly above 2% of GDP in 2019 to 2.5% in 2020.

In this environment, Asset Allocation implications are straightforward as a major uncertainty has been lifted.

Since October, Candriam holds a neutral exposure to UK equities, after an underweight stance throughout the entire Brexit episode.

Investors have started to add gradually UK assets to their portfolios but remain under-allocated to the UK. The significant risk premium attached to UK equities could decline in the coming months.

• The strengthening of the GBP is however mitigating the positive impact of the fall in uncertainty on internationally-exposed big caps quoted in London. Hence, domestically oriented UK stocks should have more traction. A limit to the rising GBP will be the subsequent negotiations on the future trading relations with the EU. The comfortable size of the majority means that PM Johnson will not be overly dependent on his euroskeptic hardliners.

Beyond the UK, the election result is a market-friendly outcome for European assets overall as it means that the EU can start working on new projects.

What’s important?
The House of Commons voted yesterday for an early general election on 12 December 2019. As expected, earlier this week, European leaders agreed to give the UK a new extension until 31 January 2020 for leaving the EU, removing the risk of a no-deal Brexit this Thursday.

What’s new?
EU leaders have agreed to extend Brexit until 31 January 2020 - meaning the UK will not leave as previously planned on Thursday, 31st of October. EU Council President Donald Tusk said it was a "flextension" - meaning the UK could leave before the deadline if a deal was approved by Parliament.

Members of the House of Commons overwhelmingly voted for an early election on 12 December (438 to 20). Liberal Democrats (Lib Dem) and the Scottish National Party (SNP) abstained.

What's next?

While the UK will have a third election in four and-a-half years before Christmas, the decision on Brexit has further been kicked down the road, and a hung Parliament after the poll cannot be excluded at this stage.

What will be the new majority in the House of Commons remains highly uncertain as the country faces unprecedented political and constitutional upheaval. Government figures showed a surge in voter registrations, with nearly two million people having registered in the past eight weeks.

PM Boris Johnson wanted an election and is now likely to take his Brexit deal to the country. The LibDems will campaign for a government to stop Brexit via revoking article 50. And the Labour party –who refused so far to clearly position itself in the spectrum of Brexit outcomes - is promising a second referendum.

Parliament will dissolve next Wednesday for a short 5-week campaign. This campaign will likely bring some volatility in the GBP and UK assets but we continue to think that on a medium-term perspective the balance of risks is no longer in favour of a lower UK currency and equities and therefore confirm our neutral tance.

What’s important?
As yesterday’s votes showed, Brexit is a hurdle race. The no-deal Brexit on October 31st is now in the hand of the EU. Donald Tusk made clear however that “a no-deal Brexit will never be our decision”. So, we continue to believe that a no-deal Brexit remains unlikely on October 31st.

What’s new?
Members of the House of Commons held two key votes yesterday:

• They passed the Withdrawal Agreement bill on the second reading by a majority of 30 (329 to 299), with 19 votes coming from the main opposition Labour Party and without support from the Democratic Unionist Party.
• They however rejected the government accelerated timetable for enacting the withdrawal agreement, as a number of Members were sceptical three days would give them enough time to go through the 110 pages of the Bill.

It appears that PM Boris Johnson is much closer than PM Theresa May ever got.

What’s next?
What will happen in the coming days remains unclear… PM Boris Johnson is weighing two options: either try to force an election and take his deal to the country or accept an extension and try to drive the legislation to completion.
As his fast track proposal was rejected, PM Boris Johnson confirmed he will set aside the legislation until the EU has “stated its intentions”. The EU States will thus have to decide whether or not they agree to grant a further three months delay to the UK until end-January 2020 (i.e. to extend article 50). The Commission will consult leaders on the UK’s request for an extension… but they may not respond very quickly… possibly waiting to see what happens next in the UK parliament. The EU could also choose another tactic and decide to offer the UK a shorter extension giving the House of Commons more time to debate on the WA … This could also prevent PM Boris Johnson to call an election before a deal is agreed on.

What are the asset allocation implications?

After neutralizing the short GBP stance in our portfolios on October 11, we decided to neutralize the underweight on UK equities in the funds we manage. Candriam had an underweight stance throughout the entire Brexit episode. We note that:

• investors are currently under-allocated to the UK;
• attractive relative valuations discount the impact of Brexit and
• political noise obscures the plausible outcomes ranging from PM Johnson’s deal to no Brexit at all.

Some short-term volatility in the GBP and UK assets are likely but on a medium-term perspective we think that the balance of risks is no longer in favor of a lower UK currency and assets.

What’s important for markets
On October 21st, the European Commission said the request for a delay had been formally received, despite its unconventional form while Germany’s economic affairs minister said “it goes without saying” that a further Brexit delay would be granted ... so a No-Deal Brexit should not happen on October 31st.

What happened?
The “meaningful vote” on the Brexit deal was ruled out by Speaker John Bercow who clearly stated that “it would be repetitive and disorderly to do so” and the government introduced the Withdrawal Agreement Bill.

What’s next?
The House of Commons will discuss and hold the vote on the Withdrawal Agreement Bill, i.e. an amendable implementation into UK law of the draft international treaty negotiated last week in Brussels. Losing this vote tonight would kill the bill.
Based on the timetable for the rest of the bill’s passage (the “Program Motion”), PM Boris Johnson will try to get the legislation passed by Thursday 24th, but this could prove challenging. Losing the Vote on Program Motion, also tonight, would make it very hard to hit the October 31st deadline.
There are potentially many controversial issues MPs would want to spend more time. The bill will for instance have to clarify how the UK will make "divorce bill" payments to the EU in the coming years, how the new customs and regulatory border between Northern Ireland and Great Britain will work in practice… MPs will thus be able to re-write the bill and vote on changes or add-ons. Some could also attempt to make the Brexit deal conditional on approval from the public in another referendum. Even if the Withdrawal Agreement Bill obtains Parliamentary approval by the end of this month an election cannot be long delayed because the Johnson government has no workable majority. The outcome of this election is more than usually uncertain...

What’s important?
The triggering of the Benn Act on Saturday reduces further the probability of a no deal Brexit on October the 31st as it is now up to the EU to decide whether or not it wants a no-deal Brexit in the coming days…

What happened on Saturday October the 19th?
The meaningful vote did not happen last Saturday. Instead of voting on the deal, MPs voted in favour of an amendment – called the Letwin’s amendment. This amendment withholds approval of the deal until the legislation to implement it has been passed.
PM Boris Johnson was thus forced by the Benn Act to send a letter asking the EU for a new delay. He sent the letter… but did not sign it! He also sent a second letter though, which he signed, saying that “a further extension would damage the interest of the UK and our EU partners”.

What’s next?
The PM now wants Members of Parliament to say a clear "yes" or "no" to the deal this Monday. It will be up to Speaker John Bercow to decide whether to allow the vote (as the same matter is not supposed to be debated twice by the Parliament). The government also plans to introduce the legislation to implement the Brexit deal - the Withdrawal Agreement Bill - required by the Letwin’s amendment during the coming session of the Commons.

After five days of intense negotiations, London and Brussels have finally agreed on a new version of the withdrawal agreement. However, the deal has yet to be ratified by the House of Commons on Saturday 19 October.
 
What does the new agreement contain?
No more "backstop" at the Northern Irish border
Preventing the re-establishment of a physical border between Northern Ireland and the Republic of Ireland has been a stumbling block of Brexit talks. The previous agreement provided for a backstop that kept the United Kingdom in the EU custom union. The new agreement no longer contains such a backstop.

Northern Ireland remains in the UK’s customs territory
The new agreement removes the need for a border between Northern Ireland and the Republic of Ireland.

Northern Ireland will form a regulatory area with the EU and will be aligned with European standards within the framework of the EU internal market. However, Northern Ireland will also be part of the UK’s customs territory. Immediate consumption products coming from Great Britain will not be subject to any tax, as they remain on the UK market. If products from third countries enter Northern Ireland and remain there, then UK customs duties will be applied. If the goods (still from third countries) are destined to enter the EU via Northern Ireland, then the UK authorities will apply EU customs duties. Both customs and regulatory controls will be carried out between the Great Britain and Northern Ireland and will be the responsibility of UK customs officials.

No veto power of Northern Ireland over the new agreement, but a consent mechanism
Four years after the end of the transitional period, the Northern Ireland Assembly may decide – by a simple majority vote of its members – whether or not to continue to apply the EU rules.

A political declaration
The agreement contains, as the previous one, a political declaration - therefore non-binding. It only outlines the future relationship between the United Kingdom and the EU that will be the subject of future negotiations if the agreement is ratified.

Will the agreement be ratified by the House of Commons?
The vote is scheduled for Saturday. If ratified by the House of Commons, the United Kingdom will leave the EU after a transition period that will last until the end of 2020 and can be extended by an additional one to two years if Brussels and London agree on this point. However, for the time being, the end result of the vote is far from certain. The leaders of the Northern Irish Unionist Party DUP – which has ten seats – have announced that they are opposed to the agreement, as has the Scottish National Party (SNP). Jeremy Corbyn, the leader of the Labour opposition, also called on MPs to reject the text. The positions of the various parties may of course change by Saturday... and there is no guarantee either that MPs follow the parties' voting instructions.

What if the House of Commons does not ratify the agreement?
If the UK Parliament rejects the agreement, then, under the so-called Benn Act, Prime Minister Boris Johnson must ask for an extension of Article 50... which the EU has then to accept. However, there is still some doubt as to whether the Benn Act is truly binding or not. Especially since Prime Minister Boris Johnson repeatedly said that he would refuse to ask for an extension (he could also try to find other ways, for example asking the EU to refuse his call for an extension while having officially requested one!). However, the most likely scenario remains that the UK asks for an extension. If the EU accepts it, new elections or a new referendum are likely to take place....

At this stage, the outcome of the vote on Saturday 19 October is uncertain. But we believe a no-deal Brexit on October 31 is relatively unlikely.

What are the asset allocation implications?
Impact on the currency
Since taking office at end-July, the chances of a No Deal crash-out by end-October (and beyond) have fallen dramatically. In our view, the best barometer of this risk is the British pound. We have been short GBP through the summer months but neutralized this position at the end of last week as early signs of a common willingness to resolve the deadlock emerged. If the Bank of England were the only central bank in the Western world to put rate hikes on the table following a smooth Brexit, a further currency appreciation would become likely.

Impact on European equity markets
In our asset allocation, we have kept an underweight stance on UK equities and will increase our exposure when we find a better risk / reward. In particular, two sources of risk remain beyond the Brexit deal: negotiations on the future relationship with the EU and other trade partners during the transition phase and an upcoming general election. This implies further uncertainties for UK assets. We doubt that the corporate sector will roll out significant capex programs in this context. The decline in the Brexit risk premium is however a positive catalyst for domestic UK stocks, who register less negative implications from a strengthening GBP than the more internationally-exposed large caps listed in London.

We reach a more straightforward conclusion on continental European equities. Clearly, the Brexit deal is good news, even a relief, for Eurozone equities and we see our overweight stance comforted for now. After the shift towards a pro-Euro government in Italy, the (likely) Brexit resolution means that political risk in the region has fallen. Looking forward, this means that two major potential growth shocks have virtually disappeared, making investments for non-European investors more attractive.