Crunch time again for May’s Brexit agreement

Thought of the day

by Chief Investment Office 15 Jan 2019

UK Prime Minster Theresa May's EU withdrawal agreement goes to a vote in the UK parliament later today. All indications point to the government losing the vote, with the remaining question being the margin of defeat.

We see several possible outcomes from tonight's vote:

  • If the government loses it, May must present her plan to parliament on how to proceed by Monday, 21 January. This will give an indication of the direction of negotiations, whether the UK government will seek a delay to the 29 March exit date, move toward a softer Brexit by renegotiating the Political Declaration on the Future Relationship, or pursue further EU reassurances on the temporary nature of the Irish backstop. If the margin of defeat is 70 votes or fewer, we believe May will more than likely seek to pursue the last of these options and look to hold another vote on the Withdrawal Agreement.
  • If the government loses by a big margin - say, 100 votes - Jeremy Corbyn, the leader of the opposition Labour Party, is likely to table a vote of no confidence in Theresa May's government. Corbyn has said he would do so at the point he sees the government at its most vulnerable, so the precise timing remains uncertain. In our view May would likely survive the vote and move onto the next stage of negotiations. In the event of a sizable defeat, trying to renegotiate the backstop would be a more difficult (but not impossible) option to pursue, thus a change in direction toward a softer Brexit or a delay could result.
  • Our base case remains for the path of least resistance: the deal being eventually passed in some form by parliament. The risk of a General Election and even a second referendum looms in the background, although is not part of our base case. In the event either outcome came to pass, delays to the exit process would be highly likely.The range of probable vote outcomes all points to further negotiations, potential delays and prolonged uncertainty, which suggests volatility will remain elevated. Currency markets are pricing in a lower likelihood of a hard Brexit - 3-month 25 delta risk reversals in GBPUSD show a less negative view of sterling. But while this tail risk may be reduced, were it to materialize it would drive sterling sharply lower, with GBPUSD potentially falling to 1.15 and EURGBP rising to parity, in our view. So we recommend a cautious approach to the pound, protecting against near-term downside in it while expecting it to appreciate longer term (our 12-month forecasts are 1.40 GBPUSD and 0.86 EURGBP). In UK equities we favor a diversified dividend strategy that involves selecting stocks with some combination of a high yield, potential for dividend growth and a dividend comfortably covered by earnings.

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