Brexit: Kicking the Can

24 Jan 2019

Terence Moll, Chief Strategist

What happened?

The word "historic" was used a lot this week. Despite last minute appeals to back her Withdrawal Agreement, the margin of defeat suffered by Theresa May’s government was the largest since 1924. However, it’s not entirely fair to blame May in a way you would usually apportion blame to the standing Prime Minister for such a large defeat. Brexit is bigger than May. The withdrawal agreement fell apart from the contradictions between the promises May felt she had to make and the reality of economics, parliament and the Northern Ireland border. A large defeat would often be followed by the government losing a vote of no confidence but even that didn’t happen as the fear of a Jeremy Corbyn government was too much for Remain-leaning Conservative MP’s to stomach.

What happens next?

Prepare for the word "historic" to continue being used a lot – because the problem seems so intractable. For example, the Prime Minister is refusing to rule out a ‘No Deal’ Brexit while the Chancellor is promising businesses that the government will avoid a ‘No Deal’ Brexit. All the while, the leader of the opposition is refusing to meet with the Prime Minister because she refuses to rule out the thing that the Chancellor is telling business will be ruled out. You see? So let’s try and focus on what we know. There is legislation in place to take us out of the EU on 29 March 2019. But there is also legislation in place to force the government to present a Plan B option. The combination of May’s deal being rejected by parliament and increasing parliamentary support to avoid a No Deal Brexit (even from cabinet ministers publicly contradicting the Prime Minister) suggests Brexit should drift towards a softer economic outcome. However, as things stand Plan B can include all of the main choices: a second referendum, a Norway-style option and still a No Deal option. We have to wait till Monday 21 January to find out and Tuesday 29 January for Parliament to vote on it. Looking beyond this, if a No-Deal is avoided all other options require an extension to the Article 50 deadline.

"We continue to look to insulate the portfolios from large swings in the currency by holding less foreign currency than the benchmark."

Portfolio implications?

It has been 7IM’s long standing view (attached) that 29 March would not see a resolution to Brexit. We called this scenario "Keep Kicking the Can". This was based on two assumptions 1) there is historical precedent for the EU to face tough problems by kicking the can and 2) despite the strong words from the UK government, it is still constrained by an electorate that favours a positive economic outcome over anything else. This meant the Brexit can will be kicked until the UK moves closer to the EU’s preferred outcome – a soft economic option. So we continue to look to insulate the portfolios from large swings in the currency by holding less foreign currency than the benchmark. However, even though we think a No Deal Brexit will be avoided we cannot rule this out. This is why we remain underweight UK equities for the time being despite the value that appears to be opening up in the asset class.

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