After UK markets displayed Brexit-related euphoria this week as hopes for an October deal peaked following a constructive meeting between Boris Johnson and Irish Prime Minister Leo Varadkar, British and European Union officials are again growing increasingly pessimistic about the chances of securing a Brexit deal in time for this week’s EU summit. The change in tone follows resistance from Boris Johnson’s Northern Irish allies, the Democratic Unionist Party (DUP) to support his revised draft deal. As securing a deal this week is imperative for the Prime Minister’s plans to exit by the 31st October without requesting a further extension to the Article 50 deadline, it is clear that its now crunch time for Brexit negotiations, with the risk of a potential no-deal outcome continuing to loom over the UK economy.
How Important is the DUP in negotiations?
The DUP’s support will be crucial if the Prime Minister is to get his agreement through Parliament later in the week, with Brexit hardliners the European Research Group (ERG) also announcing that they would only support a deal with the DUP’s seal of approval. According to former Brexit Secretary David Davis, securing the DUP’s support will be key to getting Conservative MPs to vote for a deal.
According to reports, the DUP has accepted the need for a customs border in the Irish sea, however it still wants the Northern Irish Assembly in Stormont to have a veto over the arrangements, arguing that this would be crucial to keep the peace in Northern Ireland. As Brexit-uncertainty has yo-yoed this week between pessimism over a “near-impossible” deal verses extreme optimism over a deal to be agreed this month, financial markets have remained highly volatile, with the pound whipsawing alongside bond yields and UK equity markets. It is clear that the Brexit outcome will have a significant impact on the outlook for UK assets, therefore we expect to see further volatility in UK assets as we approach the 31st October deadline.
Where does the EU stand on the deal?
Despite reports that the DUP is the only thing standing in the way of a deal with the EU, EU officials remain concerned that the revised plan leaves open the possibility that Britain could undercut the EU in areas such as taxation, state subsidies and environmental standards. Michel Barnier, Chief EU negotiator is expected to update ambassadors later today ahead of tomorrow’s European Council Summit, however securing a deal before the weekend is appearing increasingly challenging.
After two days of talks, British and EU officials say that negotiations are stuck, with Johnson unable to persuade the DUP and hard-line Brexiteers to back the draft deal. This week’s talks represent a crucial point in negotiations, with the Prime Minister needing to have a deal approved by Saturday or he will be told to seek an extension, which will likely prompt another battle and further risks of a no-deal Brexit.
What is the most likely outcome?
As it stands, we remain in the dark over whether a deal has been reached today, however it appears unlikely in our opinion given the position of the DUP, and even if a deal is agreed, it is highly unlikely that it would get through both the EU-27 leaders and the House of Commons later this week. The parliamentary arithmetic continues to work against Mr Johnson following his expulsion of Tory MPs earlier in the year, while Labour’s threat to deselect its own MPs if they were to vote for a deal means that most Labour MPs will continue to oppose any deal brought to the House. Ahead of the EC Summit starting tomorrow, an EU diplomat has claimed that unless there’s an agreed legal text by tonight, there’s no chance that a deal will be struck at the EU leaders’ summit this week.
Given that a deal must be secured by the weekend to avoid a further extension, a further summit is not being contemplated by UK side at this point. It appears that the EU is expecting to grant a further extension, and therefore in their view an emergency summit becomes unavoidable. As a deal is now looking unlikely, our expectation is that an extension will be granted, prolonging Brexit uncertainty into the new year and potentially bringing about a General Election.
Positioning
After markets were dominated by Brexit-related optimism over the week, the portfolios suffered as equities gained while UK gilt yields rose, resulting in a decline in bond prices. While this resulted in a stark intra-week movement, it should be highlighted that we view this as being temporary and due to high levels of volatility while we await a Brexit outcome, with the expectation that this week’s movements will be quickly reversed. It remains uncertain whether any real progress will be made over the coming days, and before an outcome becomes clear, the UK economy remains in limbo, with the central bank unable to act with confidence given the uncertain nature of the outlook. Given recent developments, we expect to see a further extension to the Brexit deadline, and as the economic data continues to deteriorate we retain a negative outlook on UK equities, expecting UK bonds to benefit from a risk-off rotation in the near term. This week’s euphoria is expected to be short-lived, and the portfolios remain well positioned to benefit given market conditions going into the final quarter of the year.
Key Events This Week:
- Thursday: UK Retail Sales for Sept, Start of the European Council Summit 17th-18th.
- Friday: China Q3 GDP and Industrial Production data for Sept.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document attached and the economic data set also attached.
Model Portfolios & Indices
Over the week, most global equity markets rallied due to optimism over a US-China trade deal and a potential Brexit deal despite rising downside risks in the global economy. Markets remained highly volatile over the week as the data remained weak and as trade optimism peaked, before abating today as it appears that optimism may have been overdone.
Safe haven assets such as gold remained relatively flat over the week as bonds declined on risk on sentiment owing to trade optimism, with bond yields rising over the week. It is clear that geopolitical tensions remain, and the economic data continues to illustrate weakness in the global economy, with risks now firmly tilted towards the downside. The OBI portfolios remain defensively positioned with limited equity exposure and a downward tilt which seeks to benefit when equities decline, and our portfolios remain well positioned given current conditions. The portfolios declined over the week owing to a temporary risk-on shift, however it is key to note that we view this as short-lived euphoria which will be reversed in the coming weeks.
As we progress from here, it is important to recognise that we should not let benchmark performance make us feel like we have missed out on anything, because although we have in the short term, recent performance shows how quickly this can be reversed given current levels of risk and uncertainty.
Overall, it is our view that equity markets will continue to decline before adjusting to the new norm based on lower global growth and weaker corporate profitability. The key point here is to take a long-term view, look at the current level of uncertainty in the global economy, and remember that the portfolio is designed to minimise your exposure to risk and preserve capital. Markets are behaving irrationally, therefore the most sensible strategy is a defensive one given current market conditions.
Important Information
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested.
Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 2011, Fauja Singh, a 100 year old man became the oldest person to run a marathon. The British runner completed the 26.2 mile Toronto Waterfront course in eight hours, 25 minutes and 16 seconds- proof that you’re only ever as old as you feel!
Have a great week,
Jason & Gina
