More Posts
Looking for more information on fixed income trends and market opportunities?
Seeking Additional Uncertainty? Brexit Brings It
- By Katharine Neiss, PhD, Chief European Economist, Global Macroeconomic Research, and Mehill Marku, Senior Investment Strategist
- October 8, 2020
In a year of abject uncertainty, there is still some clarity to be found: Brexit is happening and the UK’s relationship with the European Union will never be the same. Beyond that, Brexit remains mired in uncertainty that will affect the British economy and investors’ allocation decisions for years to come.
The UK’s recently tabled Internal Market Bill, which would unilaterally override provisions in the Withdrawal Agreement, has once again raised the prospect of a no-deal Brexit and severing decades-old economic ties between the UK and the EU. Yet, the introduction of the Bill has not totally extinguished the potential for a deal, as skinny as one might be, which could still help cushion some of the Brexit-related impact on the UK economy. Given the deterioration in the economic outlook1 amidst the Covid crisis and the need for both sides to remain engaged in many areas of common interest, our base case is that a so-called “skinny deal” will likely be reached by the end of October or early November and in time to be ratified by the respective parliaments.
However, the somewhat acrimonious split raises longer-term implications. Perhaps the most important result of the current negotiations is its effect on the mutual trust between the UK and the EU going forward. Furthermore, the Bill undermines the UK’s reputation as a negotiating partner and hurts its prospects for future trade agreements with other countries, including the U.S., in its post-Brexit existence. It has also been cited as a risk to the Northern Ireland peace process and giving new impetus to the Scottish drive for independence, where the voting majority is now in favour of a break from the UK.
A Closing Window of Options
Unlike the period following the 2016 Brexit referendum, which allowed for a broad spectrum of possible outcomes, far fewer options are now left on the table. The so-called “skinny Canada deal”2under discussion would allow for tariff-free goods trade, but that’s pretty much it. For a services-based economy, such as the UK’s—which is vastly different than Canada’s commodity-heavy exports—such a deal would leave the bulk of UK trade subject to a new set of still unestablished rules. The bottom line is that, deal or no deal, the UK’s new trading relationship will be very different to the one it had as a member of the EU, and that in turn means the economic consequences of Brexit are largely baked in.
Businesses More Prepared, But Few Will be Left Unscathed
The good news is that businesses appear more prepared for the potential extra requirements of trading with the EU once the transition period concludes. For example, in September, 61% said that they were either fully prepared or as ready as they could be, which was up from 54% when the survey first asked the question in February 2020 (Figure 1).
Figure 1: Post-Brexit Trade Preparedness (% of UK businesses that trade with the EU, survey responses*)
Despite the signs of preparation, the gravity of the situation remains palpable, particularly given the additional challenges from the Covid pandemic. A recent study found that the industries most affected by the Covid shock may be the least affected by Brexit, suggesting that no corner of the UK economy will be spared between the two (Figure 2).
Furthermore, a survey taken over the summer by the Descartes Business Group found that two-thirds of large firms are very or extremely concerned about delays in their supply chain impacting their business post-Brexit and noted that their Brexit preparations have been disrupted by Covid-19. Indeed, the UK government has outlined a plausible worst-case scenario of significant congestion between the Dover-Calais crossing, a major hub for goods trade in the UK. So, another key takeaway is that, deal or no deal, the UK will experience a degree of economic disruption in the early part of next year.
Figure 2: Industries Ranked by Performance During Economic Shocks*
It May Not be 2016 for the Markets, But…
The anticipated market reaction to the current trade negotiations could follow the patterns forged throughout the Brexit process. In a hard break, no-deal scenario, sterling may weaken further—possibly along with a slight weakening in the euro—while UK gilt yields may decline, and spreads on UK-centric and deal-sensitive credits could widen. However, a decent amount of that anxiety may already be priced into the market, so the reaction could be more subdued than the one following the referendum.
On the other side, a friendlier break with a trade deal may have a fairly strong, positive impact on sterling, a slightly positive boost for the euro, a mild lift for gilt yields, and a positive tailwind for UK / Brexit-centric credits. To that end, we remain solidly overweight UK credits in our European investment grade and high yield strategies.
Brexit is a Process, Not an Event, and Its Uncertainty Will Remain for Years to Come
Beyond needing to negotiate a new trade agreement, the UK and EU will need to agree to arrangements covering a whole host of issues, such as transport, data protection and financial services, to name a few. The task and the uncertainty that it creates adds another item to the “unprecedented” list of recent developments as the separation unwinds more than 40 years of economic integration.
Furthermore, the Vote Leave campaign was primarily about taking back control; so, what will the UK do with its new-found sovereignty? Whether the vision is for a “Singapore-on-Thames” or “State Aid for Winners,” there has been surprisingly little public debate on the desired future state of the UK. The ambiguous vision coupled with a new trading arrangement, which will be anything but comprehensive, sets the UK on a course for regulatory competition as it diverges from the EU. As the UK looks to define its future, there is little doubt that its historic task could be made even more uncertain by a deep freeze in its relationship with the EU, rather than the current, mild chill.
This material reflects the views of the authors as of October 8, 2020 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
1Our forecast for real GDP growth in the UK is -10% in 2020 and 7.0% in 2021.
2Modelled on the Comprehensive Economic and Trade Agreement between Canada and the EU.
Katharine Neiss, PhD
Katharine Neiss, PhD, is a Principal and Chief European Economist for PGIM Fixed Income, based in London. Ms. Neiss covers the macro-economic outlook in the UK and euro area, including Bank of England and ECB policy. Prior to joining the Firm in 2020, Ms. Neiss was Head of the International Surveillance Division at the Bank of England, responsible for briefing policymakers on the global macro-economic and financial stability outlook. Previous roles at the Bank of England include Head of the Policy, Strategy and Implementation Division, covering regulation of major UK banks, and senior manager roles in the Structural Economic Analysis Divisions, covering the UK economy. Ms. Neiss has published several articles in peer reviewed academic journals on topics ranging from real interest rates as a monetary policy tool and the impact of the global financial crisis on supply. She received a BA Honours in Economics from Queen’s University and holds a Masters and PhD in Economics from the University of British Columbia.
Mehill Marku
Mehill Marku is a Vice President, Senior Investment Strategist at PGIM Fixed Income. Prior to assuming this position he was a portfolio manager for PGIM Fixed Income's Foreign Exchange Team. Previously, Mr. Marku was a Senior Associate assisting in global bond and foreign exchange management, trading, and analysis. He was also previously an analyst in PGIM Fixed Income’s Portfolio Analysis Group, focused on monitoring and quantifying portfolios' risks relative to their benchmarks, as well as evaluating and measuring total return performance and attribution. Mr. Marku also worked in PGIM Fixed Income’s Structured Finance Group, as well as the Asset Liability and Risk Management area, where his work focused on performance attribution, asset valuation, and risk management. He joined the Firm in 1998. Earlier, Mr. Marku served as Deputy Foreign Minister in Albania's Ministry of Foreign Affairs, negotiating economic and technical assistance programs with the European Union Economic Commission and Council of Europe, and leading Albania's efforts to join multilateral political and financial institutions. Mr. Marku received a BA from Tirana University, Albania, an MA in Public Affairs from Princeton's Woodrow Wilson School of International Relations, and an MBA from New York University.
PGIM Fixed Income operates primarily through PGIM, Inc., a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended, and a Prudential Financial, Inc. (“PFI”) company. Registration as a registered investment adviser does not imply a certain level or skill or training. PGIM Fixed Income is headquartered in Newark, New Jersey and also includes the following businesses globally: (i) the public fixed income unit within PGIM Limited, located in London; (ii) PGIM Netherlands B.V. located in Amsterdam; (iii) PGIM Japan Co., Ltd. (“PGIM Japan”), located in Tokyo; (iv) the public fixed income unit within PGIM (Hong Kong) Ltd. located in Hong Kong; and (v) the public fixed income unit within PGIM (Singapore) Pte. Ltd., located in Singapore (“PGIM Singapore”). PFI of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. Prudential, PGIM, their respective logos, and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.
These materials are for informational or educational purposes only. The information is not intended as investment advice and is not a recommendation about managing or investing assets. In providing these materials, PGIM is not acting as your fiduciary. These materials represent the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered and to such person’s advisers is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of PGIM Fixed Income is prohibited. Certain information contained herein has been obtained from sources that PGIM Fixed Income believes to be reliable as of the date presented; however, PGIM Fixed Income cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. PGIM Fixed Income has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. All investments involve risk, including the possible loss of capital. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or an y investment management services and should not be used as the basis for any investment decision. No risk management technique can guarantee the mitigation or elimination of risk in any market environment. Past performance is not a guarantee or a reliable indicator of future results and an investment could lose value. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. PGIM Fixed Income and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of PGIM Fixed Income or its affiliates.
The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.
Conflicts of Interest: PGIM Fixed Income and its affiliates may have investment advisory or other business relationships with the issuers of securities referenced herein. PGIM Fixed Income and its affiliates, officers, directors and employees may from time to time have long or short positions in and buy or sell securities or financial instruments referenced herein. PGIM Fixed Income and its affiliates may develop and publish research that is independent of, and different than, the recommendations contained herein. PGIM Fixed Income’s personnel other than the author(s), such as sales, marketing and trading personnel, may provide oral or written market commentary or ideas to PGIM Fixed Income’s clients or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part 2A of PGIM Fixed Income’s Form ADV.
In the United Kingdom, information is issued by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418). In the European Economic Area (“EEA”), information is issued by PGIM Netherlands B.V., an entity authorised by the Autoriteit Financiële Markten (“AFM”) in the Netherlands and operating on the basis of a European passport. In certain EEA countries, information is, where permitted, presented by PGIM Limited in reliance of provisions, exemptions or licenses available to PGIM Limited under temporary permission arrangements following the exit of the United Kingdom from the European Union. These materials are issued by PGIM Limited and/or PGIM Netherlands B.V. to persons who are professional clients as defined under the rules of the FCA and/or to persons who are professional clients as defined in the relevant local implementation of Directive 2014/65/EU (MiFID II). In certain countries in Asia-Pacific, information is presented by PGIM (Singapore) Pte. Ltd., a Singapore investment manager registered with and licensed by the Monetary Authority of Singapore. In Japan, information is presented by PGIM Japan Co. Ltd., registered investment adviser with the Japanese Financial Services Agency. In South Korea, information is presented by PGIM, Inc., which is licensed to provide discretionary investment management services directly to South Korean investors. In Hong Kong, information is provided by PGIM (Hong Kong) Limited, a regulated entity with the Securities & Futures Commission in Hong Kong to professional investors as defined in Section 1 of Part 1 of Schedule 1 (paragraph (a) to (i) of the Securities and Futures Ordinance (Cap.571). In Australia, this information is presented by PGIM (Australia) Pty Ltd (“PGIM Australia”) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). PGIM Australia is a representative of PGIM Limited, which is exempt from the requirement to hold an Australian Financial Services License under the Australian Corporations Act 2001 in respect of financial services. PGIM Limited is exempt by virtue of its regulation by the FCA (Reg: 193418) under the laws of the United Kingdom and the application of ASIC Class Order 03/1099. The laws of the United Kingdom differ from Australian laws. In South Africa, PGIM, Inc. is an authorised financial services provider – FSP number 49012. In Canada, pursuant to the international adviser registration exemption in National Instrument 31-103, PGIM, Inc. is informing you of that: (1) PGIM, Inc. is not registered in Canada and is advising you in reliance upon an exemption from the adviser registration requirement under National Instrument 31-103; (2) PGIM, Inc.’s jurisdiction of residence is New Jersey, U.S.A.; (3) there may be difficulty enforcing legal rights against PGIM, Inc. because it is resident outside of Canada and all or substantially all of its assets may be situated outside of Canada; and (4) the name and address of the agent for service of process of PGIM, Inc. in the applicable Provinces of Canada are as follows: in Québec: Borden Ladner Gervais LLP, 1000 de La Gauchetière Street West, Suite 900 Montréal, QC H3B 5H4; in British Columbia: Borden Ladner Gervais LLP, 1200 Waterfront Centre, 200 Burrard Street, Vancouver, BC V7X 1T2; in Ontario: Borden Ladner Gervais LLP, 22 Adelaide Street West, Suite 3400, Toronto, ON M5H 4E3; in Nova Scotia: Cox & Palmer, Q.C., 1100 Purdy’s Wharf Tower One, 1959 Upper Water Street, P.O. Box 2380 – Stn Central RPO, Halifax, NS B3J 3E5; in Alberta: Borden Ladner Gervais LLP, 530 Third Avenue S.W., Calgary, AB T2P R3.
© 2021 PFI and its related entities.
