The Weekly: Backstops and Deal Mongers

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19/11/2018
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At last we have some clarity – we have a Brexit withdrawal deal. But for some, not a deal as they would know it. Business appears to be broadly supportive because it allows them to plan ahead and achieve some certainty from March 2019, avoiding the cliff-edge of no deal. However, unless you have just landed from Mars, you will know that the next few weeks is crunch time for Brexit and the point of no return, deal or no-deal.

Stepping back from all the political jousting is vital to achieve rational understanding. Politicians by their very nature are highly ambitious personalities driven by power and, at times like this, animal instincts. These traits are being exposed as the arguments become personalised, bigoted and dogmatic. The Labour party leadership will vote down the deal for party-political reasons whilst the hard Brexiteers will vote it down for personal ambition – neither of which consider the greater good of the country or the impact of a no deal in terms of jobs, employment security or business investment.

Many a marriage survives because the implications of divorce are too painful either financially or for reasons of family unity. Losing financial security and potentially contact with children is too high a price to pursue a happier relationship elsewhere. However, those that do push the divorce button do so because the current situation is just too intolerable or there is a known preferable alternative available. That is substantially why some voted vehemently for Brexit, others were agnostic but may have casually protest voted for change, whilst others were not sufficiently anti-EU to risk taking the plunge, whilst being well aware of the negatives in terms of cost, loss of sovereignty and immigration.

Now that we have a decree nisi, the true implications of the withdrawal agreement can be considered and the outspoken views of the political objectors and supporters can be put into context. Take the views of Boris Johnson who says we will pay £39bn, give up all our influence and become a vassal state. Is this actually true, or is this just political bluster from a self-interested would-be Prime Minister?  

This depends on how distrustful you are of the EU and their pledge to negotiate a trade deal which works for both sides. His view, and that of other outspoken ‘deal mongers’, is based on the backstop deal being the actual deal, believing there to be no incentive for the EU to agree to anything better. Both Theresa May and Michel Barnier have said the backstop is not designed to be used. Yet, the reality is that when we get into the trade deal negotiations, if the EU want to, they can fall back to this position, which is a vassal state arrangement for the UK. It is an insurance policy for the EU but does not deliver Brexit.  It would put the UK in a halfway house of losing EU influence but still effectively remaining within the EU, with no freedom to negotiate trade deals. As a worse-case scenario, this really does stack the odds in the EU’s favour and would deliver the softest of Brexit outcomes if it became permanent.

So, Boris is sort of correct on the assumption that the EU is not prepared to negotiate a trade deal that we could accept. Bearing in mind the comments of two years ago that our EU trading relationship must be inferior to that which we currently have, to avoid undermining EU membership, then the UK will pay a price when it comes to trade. When and if that part of the trade negotiation becomes a reality, there will be absolutely nothing we can do about it because we will have signed up to the withdrawal agreement and our only option will be the backstop. The EU will have us over a barrel. The quote that ‘nothing is agreed until everything is agreed’ no longer applies.

Don’t be surprised if all 27 EU countries back the withdrawal agreement on 25th November. This should ring alarm bells loudly to anyone that brokers deals on a regular basis.  If the other party agrees without any fuss and bluster, then you haven’t driven a hard enough bargain or spotted how you’ve been duped. Not unlike selling a house, if you get twenty-seven offers at the full asking price within two weeks of going on the market, you have undersold your asset.

Moving back into the world of political power struggles. It is revealing that no-one wants to be the Brexit Secretary. David Davis was the first to resign over Chequers and now Dominc Raab over the backstop, whilst Michael Gove and Geoffrey Cox both turned the job down. Who would want to be connected to the resulting trade deal negotiations where the EU have all the aces? We read that the accepting appointee, Stephen Barclay, will not negotiate with the EU but will be responsible for the domestic delivery of the EU withdrawal, preparations for Brexit and shepherding legislation through parliament. Theresa May will be personally responsible for the trade negotiations if she survives. That’s probably just as well, as it is her deal.

It could be argued that Theresa May has reluctantly brokered a deal that she knew would fail to get through parliament, rather than walk away, staring into the chaos of no deal. She is more likely to survive under the former scenario than the latter. Her speech last week after the big cabinet meeting opened the window to no Brexit at all, which has set the hares running. Some are saying that parliament would have to approve no deal whilst others are saying this isn’t the case – the usual opaque legal opinion from two partisan ex-lawyer MPs. Whether or not a no deal scenario needs a commons vote is probably moot. Gina Miller won her case against the government in 2016 whereby she secured the requirement for parliament to approve the implementation of Brexit and trigger Article 50. Surely, as the agreed deal needs to go through parliament, then a no deal should also have to be approved given the significant implications.  

This is where the second referendum probably has a place. Business leaders are generally supportive of the withdrawal deal in full knowledge that the trade negotiations are outstanding. Their businesses have at least a two year window of continuity and no cliff-edge. This is infinitely preferable to who knows what in 19 weeks’ time. Ultimately, as President Trump is finding, when global trade arrangements have been in place for a considerable time, infrastructure, facilities and supply chains have become hard-wired into businesses. It is then nigh on impossible for any business to make a decision on future investment when democracy could well remove those leaders in the next two years or so. This means that our trading relations with the EU are so ingrained within our economic, customs and business processes that it becomes impossible to extricate ourselves without causing significant uncertainty and fears over economic damage, job losses and hardship.

It is this tack that Theresa May is probably now following. If she can get the backing of industry who will then reassure the populace regarding their jobs which could be vulnerable under a no deal scenario, then a second referendum when parliament votes her deal down could either accept the deal or cancel the whole thing. Only the hardest of Brexit supporters envisaged accepting no deal and the potential economic chaos. It should not be forgotten that Theresa May was a remainer and this way, she will give the people what they want and she survives. Her personal backstop could be to cancel the whole thing via a second referendum or deliver a vassal state because the people and business voted for it. Parliament would be irrelevant under this scenario.

She is currently encountering her ‘put up or shut up’ moment akin to John Major when he had a slim majority government and the rebels rose up. If she survives, the rebels will be muzzled for some time and their attempted backstab over the backstop will have failed. Our reservations regarding the final deal remain but, in time, the UK can hopefully rebuild our trading relations with the rest of the world, even if we end up with a significantly inferior EU trading relationship and not the backstop.  It is remarkable how resilient the UK economy has been, considering all the turmoil. This suggests that very soon, once certainty is achieved, with a weaker or stronger sterling, eventually we will find a way through. The EU will either remain as our largest trading partner or gradually reduce over time as we trade freely with other nations.

 

 

Political turbulence weighs on equity markets

Global equity markets closed lower last week amid continued concerns over slowing global economic growth and the chaotic Brexit developments. The UK’s FTSE 100 index closed the week -1.3% lower, whilst the American S&P 500 was down -1.6% for the week(1).  

UK economic data was somewhat overshadowed this week by political events as the fallout of a draft withdrawal treaty was revealed by the Prime Minister. Sterling came under pressure amid a chaotic backdrop; depreciating over the course of the week by -1.8% and -1.1% against the Euro and the US Dollar respectively(1).

The latest retail sales and employment data crept somewhat under the radar. October’s retail sales declined -0.5% month-on-month, as mild Autumnal weather delayed spend on winter clothing and a high oil price impacted fuel volumes(1). Tuesday’s employment report showed an increase in wage growth to 3.0% year-on-year, in line with consensus forecast and comfortably above the current rate of inflation which fell to 2.4% according to Wednesday’s latest Consumer Price Index data(1). The unemployment rate ticked up slightly as more young workers entered the labour force. There was also however a clear trend of EU nationals leaving employment in the UK.

Retail sales data in the US fared far better, seeing a +0.8% monthly rise(1). The yield on the US 10-year Treasury note though declined 9 basis points from last Friday to 3.09%, as more broad concerns of economic weakness drove sentiment lower(1).

The German economy contracted in the third quarter of this year according to Wednesday’s preliminary estimate of Gross Domestic Product. Lower than expected export numbers, despite a weak Euro were a significant contribution, whilst concerns over Chancellor Merkel’s under-pressure coalition also weighed on European equity markets. Germany’s DAX 30 and the French CAC 40 both ended the week with a drop of -1.6%(1).

The price of oil dropped again last week. A barrel of West Texas Intermediate (WTI) crude oil fell to its lowest level in nearly a year, having only just reached a new one-year high above $76 last month. Last week’s increase in US shale oil inventories led WTI prices to close the week down -5.0% at $56.89 per barrel(1). Brent crude, the primarily European benchmark ended the week at a shade over $67 per barrel, representing a weekly slip of -3.6%(1).

 

Datastream 2018 (1)

 

Week Ahead

Clearly news flows this week will most likely centre on political events as they unfold. Any further Brexit negotiations or Conservative party wrangling will likely supersede what is a fairly muted week on the economic calendar. The most likely data points of interest this week come from the US; where housing starts, building permit numbers are due on Tuesday and Durable goods orders follow on Wednesday(1). US markets close on Thursday for Thanksgiving. 

 

Forex Factory 2018(1)