May survives to fight another day

Thought of the day

by Chief Investment Office 13 Dec 2018

UK Prime Minister Theresa May survived a vote of no confidence in her leadership on 13 December. Two hundred Conservative MPs voted in favor of May staying as their leader, 117 voted against. The margin of victory looks sufficient for May to claim she has the confidence of her party and to remain in office.

We see a number of implications for the ongoing Brexit negotiations.

  • We now expect that May will remain in office to see the Brexit process to a conclusion. A decision to step down from the leadership of the Conservative Party in the next 12 months will be hers, as her own MPs cannot now challenge her during this time.
  • The next steps are for May to secure whatever assurances she can from the EU regarding the temporary nature of the backstop arrangements that form part of the Withdrawal Agreement. At this stage, we do not expect these to be material, or legally binding, so they may not be enough to satisfy her opponents when it comes to ratifying the deal in the UK parliament. If it is to pass, it will likely take more than one vote and further tweaks/reassurances from the EU.
  • What markets fear the most – a disruptive no deal outcome on 29 March – has not become any more likely. The most likely paths ahead still point to ratification of a tweaked Withdrawal Agreement or a delay to the process beyond March. No deal remains an option, but we continue to take the view that an increasingly vociferous parliament, with more tools at its disposal to intervene in the process, will prevent this outcome on 29 March 2019.But while sterling’s reaction to the confidence vote has been positive – with EURGBP falling 0.8% since it was announced there would be a vote – the outcome of the Brexit negotiations remains highly uncertain and we expect currency volatility to remain elevated. Implied volatility for three-month at-the-money EURGBP options this week traded as high as 13% from 6% in June, which was the highest it's been since the June 2016 Brexit referendum. Hedging currency risks, especially in the near term, appears prudent for investors who do not want to take a strong position on the eventual outcome of the Brexit process.

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