The Brexit deadline of March 29, 2019 is quickly approaching with no agreement yet in place. Since the referendum vote just over two-and-a-half years ago, the prolonged uncertainty has clearly weighed on the U.K. economy, business and consumer confidence, and the British pound sterling. With less than a month to go, U.K. Prime Minister Theresa May has set out a three-part plan to maintain control over Parliament’s influence in Brexit negotiations with three outcomes likely in play:

  • “Soft” Brexit, in which the U.K. leaves the EU with a deal in place

  • “Hard” Brexit, in which the U.K. leaves the EU without a deal

  • The extension of Article 50, which would delay the exit from the EU

Which of these come to pass depends on the outcome of a series of parliamentary votes set to take place next week.

Possible Outcomes and Market Reaction

Prime Minister May’s plan consists of a series of votes. On March 12, the members of Parliament (MPs) will vote on the revised negotiated deal, which would lead to a soft Brexit. If the deal does not receive a majority of votes in the House of Commons, MPs will vote on a “no deal” exit on March 13. If “no deal” Brexit is rejected, then MPs will vote on an extension of Article 50 by March 14, which would have to be approved by the EU and is rumored to be measured in months. If there is disagreement on the extension, the U.K. will leave the EU without a deal barring some extraordinary circumstances. 

Consensus views favor either a soft Brexit with the negotiated deal, or some version of it getting passed, or an extension of Article 50. The odds of a hard Brexit have dropped sharply on the assumption that MPs will not explicitly vote for a “no deal” on March 13. With that said, the possibility that the market is underestimating the potential of a hard Brexit must also be considered. There are many factions within British Parliament that may not wish to concede on any issues, thus making a compromise impossible. Failure to reach some agreement, or to at least postpone, would likely send markets lower. However, just as with the Brexit vote, such a pullback could prove to be temporary, as it is assumed that the effects of a hard Brexit would lead all sides to seek a swift resolution. 

Our view is that a deal will get done, as the realities of the economic interdependence between the EU and U.K., and the need to prevent a land border between Northern Ireland and Ireland are too significant. If the deal does get passed, we could see equity markets rally given the removal of uncertainty. The pound could potentially regain some of its lost ground and sovereign bonds could move higher. A resolution is also beneficial to the global economy as a whole.

Conversely, if the U.K. leaves without a deal, opting for a “hard” Brexit, it would be a severe hit to an already slowing European economy and to business and consumer confidence. In this case, U.K.-EU trade could continue under the rules of the World Trade Organization, which potentially may be worse than the status quo but not traumatic. Although we believe this scenario is a tail risk, equity markets and the pound would likely come under pressure if it were to occur. An extension of the deadline would add to what has been a prolonged period of uncertainty; we would expect to see greater volatility in equities and currency markets until the next deadline.

Implications for Investment Strategy

We have had a neutral weight to developed international equity markets since June 2016 given our expectation for slower growth in Europe within this long, global expansion. As anticipated, the uncertainty of Brexit has weighed on economic growth in the U.K., with GDP slowing to 1.3% in 2018 and a forecast of 1.9% for 2019 amidst a fragile housing market. Additionally, interest rate differentials between the 10-year gild and the U.S. 10-year Treasury continue to drag on its currency. The pound is relatively cheap against both the euro and USD, as illustrated in Exhibit 1, with the currency down 11% against the dollar
and the euro since the referendum in the summer of 2016. 

For now, we remain neutral on the U.K., as the slower growth outlook is further complicated by Brexit politics. We will continue to monitor developments on the negotiations and remain prepared to make any portfolio adjustments if we believe the Brexit outcome warrants a change in our forecast. We do not believe that any of the three potential outcomes will significantly change our neutral outlook on developed international equity markets given the pervasive slow-growth environment across the region. Relative to growth outlooks in other regions, the neutral positioning on international developed equity markets is warranted.

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