Brexit uncertainty persists after government defeat

Thought of the day

by Chief Investment Office 13 Mar 2019

The UK government's plan to withdraw from the EU has suffered a second defeat in parliament, despite renewed assurances from European negotiators over the contentious Irish backstop clause. Members of Parliament rejected the deal by a large margin, with 391 against and only 242 in favor. Euroskeptic lawmakers focused on an admission by the attorney general, the government's chief legal advisor, that the UK could still be unable to leave the customs union without EU consent.

The pound fell as much as 1% against the US dollar after the release of a memo from the attorney general outlining this advice, as investors anticipated a negative vote in parliament. That partly reversed two-session gains of 1.4% and 1.1% against the dollar and the euro, respectively.

But while the government's deal has now been rebuffed twice, the result of the vote still provides little clarity on the eventual outcome. This supports our view that investors should remain cautious, and avoid chasing short-term rallies in sterling or increasing exposure to UK equities.

So what comes next?

  • A delay in Brexit now looks likely. The UK had been due to depart the EU on 29 March, with or without a deal. MPs will vote tomorrow on whether they wish to exit the union without a deal. If lawmakers reject this option, as we believe is likely, another vote will help determine whether they want to delay the process. The next key question is what is on offer from the EU – a short extension or a far longer one.
  • The government and parliament will now face a series of options. One route would be for parliament to pursue the Norway model, which would include membership of the European Free Trade Association. While this could command majority support, it would go against manifesto commitments and perhaps split the Conservative party. Consequently, we doubt Prime Minister Theresa May will pursue this option.
  • A popular vote could be needed to break a deadlock. If there is little likelihood of a change in negotiating stance or any withdrawal agreement being ratified by MPs, then the inescapable conclusion is that the government will have to return to voters, most likely via a general election.
  • Extending Article 50 removes one source of concern, but the much-hoped-for clarity on the Brexit process currently feels as distant as it did on the morning after the referendum. The greater concern for the economy and markets is the unending uncertainty of what comes next. All options remain on the table.As a result, we favor a cautious approach to UK assets. Investors with exposure to UK assets should consider hedging sterling over three to six months. Within equities we recommend a diversified dividend strategy that is likely to outperform in most circumstances. In our global tactical asset allocation, we are neutral on Eurozone equities and underweight UK equities as their volatility is likely to exceed their historical norms, and we see better value in emerging market USD-denominated sovereign bonds.

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