Weekly market recap: Barnier boosts Brexit bulls
The EU’s chief Brexit negotiator, Michel Barnier, indicated last week that he was close to offering the UK a deal “such as has never been with any other third country”.
A rather amusing story caught my eye in which a set of burglars used chisels to tunnel their way into a bank. The reported loss from the incident was a grand total of £20, taken out of the company’s petty cash! Lancashire Police are investigating the failed heist, which happened over the bank holiday weekend.
Given the appreciation in sterling last week, the unlucky burglars are set to have had a windfall as their proceeds will have increased in value by 0.9% in dollar terms or 1.1% in euro terms! Asset class returns in sterling and local currency are below; most notable from the tables is that UK equities were the relative under-performer in local currency last week, thanks in part to the impact of a strengthening pound on the UK equity market.
Table 1: GBP total returns
Table 2: Local CCY total returns
Perhaps unprecedented in the history of the European Union, the EU’s chief Brexit negotiator, Michel Barnier, indicated last week that he was close to offering the UK a deal “such as has never been with any other third country”. Sterling reacted positively to this news, with the comments appearing to curb further weakness versus the USD and EUR, at least in the short term. Mr Barnier’s comments were welcomed by sterling traders who have been increasingly negative on the pound in response to the rising base case probability that the UK returns to the World Trade Organisation (WTO).
What does this announcement mean for the negotiations, the economy and the markets? Uncertainty still clouts the UK’s future trading status and subsequently affects all three.
As far as the negotiations are going, the possible outcomes still range from associated membership (rule-takers) of EU institutions such as the Single Market and the Customs Union, all the way to independent membership of the WTO. Consequently, the EU has left much of the innovative thinking as to what a future partnership should look like to the UK, all the while underlining the fact that the further from the EU the UK diverges, the more restricted its market access will be. The UK in turn remains split, thus a large portion of this uncertainty is down to Westminster infighting despite just 29 weeks to go until the end of the Article 50 process. Pro-remain groups continue to favour minimal disruption and favour closer ties with the EU and its institutions, while pro-leave groups prefer the option of a cleaner break with the bloc so as to take advantage of new political and economic opportunities that may emerge.
One of the direct effects of persistent infighting for the economy is that uncertainty weighs on how businesses prepare for the future. Many corporate managers have put off investment decisions affecting the longer-term until after a deal (or indeed no deal) has been agreed. With more positive news flow beginning to emerge and a layer of Brexit-induced uncertainty diminishing, market participants have also begun to reprice the probability of future interest rate rises at the Bank of England. This is due to the BOE Governor, Mark Carney, previously indicating that the central bank’s path to higher rates will be dependent on the outcome of Brexit.
Chart 1: Uncertainty, gauged by business sentiment, weighs on UK business investment which will likely remain suppressed until clarity emerges around a future UK-EU relationship
In turn, the markets are affected by the wider sentiment towards the UK economy, which in terms has implications for sterling. As an index that comprises of some of the world’s leading multi-national corporations generating revenues globally, the strengthening pound is a significant headwind for UK market. The FTSE 100, encapsulating the 100 largest listed companies in the UK, was particularly hurt by the pound appreciating recently, as close to 70% of its revenues are derived from outside the UK. The extent of this relationship was tested in the immediate aftermath of the vote to leave the European Union, which saw the UK’s currency significantly depreciate against its major trading partners’, pushing the exporter heavy index higher. Though far from a total reversal in trajectory, the positive news flow regarding an orderly withdrawal from the EU and the subsequent sterling strength has had a negative implication on the equity index, as the relative size of the companies’ revenues in sterling shrank.
Chart 2: Though not the dominant factor, sterling’s relative strength/weakness provides head/tailwinds for the blue-chip FTSE 100 index
A further factor likely to cause calmer markets around Brexit news flow will be whether the current BOE Governor will decide to stay until the end of his current tenure which is due to end in 2021. In October 2016, Mr Carney announced that he intended to step-down from his position early, in July 2019 – just three months after the UK’s official withdrawal date from the EU. As a key public figure who was against the UK’s decision to leave the EU, the Bank’s Governor has since taken a cautious approach to implementing monetary policy. Many anticipate that a more divisive successor, one more vocal about the UK’s position on EU membership, may unsettle markets and will be watching how this particular story unfolds in the coming months.
THE WEEK AHEAD
Monday: China Caixin Manufacturing PMI
Tuesday: Reserve Bank of Australia Interest Rate Decision, US ISM Manufacturing PMI
Wednesday: Australia Q2 GDP, Canada Balance of Trade, US Balance of Trade, Bank of Canada Interest Rate Decision
Thursday: Australia Balance of Trade, US ADP Employment Change, US ISM Non-Manufacturing PMI
Friday: Germany Balance of Trade, Eurozone Q2 GDP, Canada Unemployment Rate, US Non Farm Payrolls, US Unemployment Rate, Canada Icey PMI
STAT OF THE WEEK: 82% – the record percentage of Americans who say trade is good for the US economy (Chicago Council on Global Affairs).
Data correct as at 31/08/2018.