Wealth managers comment on the decision of UK Prime Minister Theresa May to resign after she failed to carry a Brexit withdrawal agreement through Parliament. Her announcement triggered a Tory leadership election.
After what seemed an agonising wait, the UK Prime Minister last week announced that she is to resign after her latest bid to push a Brexit withdrawal agreement through Parliament failed. The ruling Conservative Party fared badly in the European Parliamentary elections, with the nascent Brexit Party polling strongly, while the main opposition party, Labour, also lost seats. The UK is due to leave the EU unless other things change, on Halloween – 31 October this year.
At the heart of the issue is that most legislators don’t want the UK to leave the bloc – in which it has been a member since 1973 – without some form of free trade agreement. By taking “no deal” off the table (which would put the UK under the World Trade Organisation system) it has been argued by Brexit supporters that the UK has thrown away the vital lever of being able to walk away from talks. On the other hand, many legislators worry that a “no deal” Brexit will put crucial sectors, such as London’s financial industry, at risk from protectionist barriers that would be erected by the EU. Already, some banks and fund managers have set up subsidiaries in EU member states such as Ireland and Luxembourg.
May’s resignation now triggers an election for leadership of the Conservative Party. Candidates will include former foreign minister and controversial newspaper columnist Boris Johnson, former ministers such as Dominic Raab (both who support Brexit) and others, such as Home Secretary Sajid Javid, government minister Rory Stewart and former Brexit minister (and hardline Brexit supporter) Steve Baker.
Here are some responses from wealth managers in the immediate aftermath of the result.
Mark Dowding, CIO at BlueBay Asset Management
Our analysis of the current composition of Parliament suggests that any new prime minister might struggle to deliver a hard Brexit through Parliament with the Tory majority non-existent and a number of Conservatives still firmly committed as EU Remainers. Consequently, we continue to look for election risks with a new prime minister seeking a stronger mandate. Should this occur, this in turn points to a material chance that there will be a Corbyn Labour coalition government in place before the end of the year.
In the same way risks seem skewed to a weaker pound, so we would see risks skewed to much higher gilt yields with such an outcome and so continue to maintain short positions in both – even if little has really happened to either UK rates or FX since the 2016 referendum in the grand scheme of things. The Brexit endgame will be in sight before the end of the year and we therefore feel that the moment where these views may play out is just around the corner.
Charles Hepworth, investment director at GAM
As Theresa May’s immovable Brexit plan finally collides with the unstoppable force of Parliament and its voting arithmetic, her resilience has finally waned. Her resignation in two weeks’ time means that she will have held office for just a few days longer than Gordon Brown and her failure to deliver the Conservative party’s Brexit promise means that we must now face the likelihood of a hard Brexiteer successor as PM – with odds on Boris Johnson as the most likely candidate.
The pound sterling has already discounted this to some degree, falling to levels seen in the immediate aftermath of the referendum in 2016 - and the decline is almost entirely due to the lingering effects of economic slowdown and the increased likelihood of a no-deal Brexit. However, the outcome has not been entirely accounted for; whoever wins the Tory leadership race will still have to force their Brexit vision through an unwilling parliament and so the obscurity around Brexit continues. These obstacles mean that sterling is likely to come under further pressure and the UK economy can be expected to slow down as the political landscape remains impossible to predict.
Azad Zangana, senior European economist and strategist, Schroders
At this stage, bookmakers have the former foreign secretary and mayor of London Boris Johnson as favourite. The hard-line Brexiteer could easily take the UK out of the EU without a deal, in spite of parliament voting in favour of essentially removing the option. He could do this by simply failing to comply with the EU's demands that the UK should continue to follow the rules. This presumably would lead to the EU agreeing to terminate the relationship in October.
If this were to happen, we would anticipate the economy to slow down and fall into recession around the turn of the year. While the Bank of England would probably cut interest rates eventually, the expected depreciation in the pound would cause inflation to spike. The household sector has already run down its safety buffer in the form of its savings rate, therefore a contraction in demand is very likely.
Janet Mui, global economist, Cazenove Capital (part of the Schroders group)
The mixture of the unwillingness of the EU to re-negotiate, parliament's lack of appetite for a hard Brexit, and the potentially toughened stance on Brexit by the new prime minister points towards further political turmoil. It is hard to see how a compromise across various stakeholders can be resolved before 31 October. Ultimately, a political process such as snap election or a second referendum may need to take place to find a way forward.
As a result of the additional Brexit uncertainty, we expect UK economic activity to face further headwinds. The recent intensification of political turmoil has caused a sell-off in sterling to hit a 4-month low versus the dollar. At the time of writing, sterling has not reacted meaningfully after Theresa May’s resignation, hence it is a reflection that the news has been priced in. Going forward, sterling is likely to remain volatile and subject to downside risks in reaction to Brexit headlines.
Elliot Hentov, head of policy and research at State Street Global Advisors
A Tory leadership contest could still yield a surprise, but the next PM will have stronger pro-Brexit credentials than Mrs May. He or she will face an immediate showdown: seek another Brexit extension from the EU or enable a messy ‘no deal’ crash. The path towards taking that decision will be non-linear and will mean heightened volatility all through October. The odds still favour another extension as it would be an immense political gamble to enact a ‘no deal’ exit during the first 100 days in office, normally a honeymoon period. Moreover, getting to no deal would require actively shutting down parliament where there is an established majority against that. This would result in experimental procedural politics that would hobble a premiership from the outset. And lastly, a no deal exit would make life tough for the DUP, on which any PM would still be relying for support.
Thus, while tail risk has risen and recent sterling weakness reflects that, the opposite end of tail risk has also risen. Revocation of Article 50 would be political heresy, but in an extreme standoff between parliament and the new PM, it could be one of the few ways for the former to assert itself.
Mark Haefele, chief investment officer, UBS Global Wealth Management
Sterling continues to be the main channel through which investors express their views about the outcome of the Brexit process. Although there is likely to be significant uncertainty and volatility ahead, we remain alert for opportunities arising from the market reaction to the UK political situation. Sterling is undervalued, especially relative to our estimate of its purchasing power parity.
The appropriate response for individual investors will vary depending on their exposure to sterling and UK assets.
For global investors with limited exposure to the UK, we believe it is time to prepare to be cautiously adding exposure to the pound. Sterling looks cheap, which in itself suggests a long-term buying opportunity. But we feel it is still too early to take large positions. The outcome of the Brexit process remains hard to predict, and volatility is likely to remain high. That said, after the resignation of May, our bias is to buy the dips below $1.24 and start unwinding hedges as soon as the political situation allows. If investor anxiety pushes the pound as low as $1.15, the case for larger long sterling positions would strengthen.
For global investors with an existing exposure to UK assets, we recommend a careful review of positions using the above scenario analysis. We have long recommended that such investors consider hedging to protect against further sterling weakness; we think it is too early to unwind these hedges.