That’s the view of George Lagarias, chief economist at Mazars, here with three things investors should watch this week
- Despite the recriminatory rhetoric on both sides, Lagarias believes that the possibility of a last-minute limited deal, Mazars’ base case scenario, is very much alive – a net positive for Sterling risk assets. However, if Friday passes with yet another impasse, then the base case scenario will lean towards a cliff-edge Brexit and more negotiations after January.
- Given the size of the stimulus already in the economy, a definitive no-deal Brexit would probably mean much higher levels of debt, possibly causing credit rating downgrades and a structurally weaker Pound.
- Long term investors should not solely focus on “when” but on “whether” the deal will materialise, and possibly consider the merits of tactical allocations on distressed assets.
Another key week for Brexit is lost as negotiating parties remain deadlocked, causing Pound Sterling to retreat. Despite the recriminatory rhetoric on both sides, we feel that the possibility of a last-minute limited deal, our base case scenario, is very much alive, which would be a net positive for Sterling risk assets. However, if Friday passes with yet another impasse, then the base case scenario will lean towards a cliff-edge Brexit and more negotiations after January. On the table is the nature of £294 billion of UK exports to the EU (43% of all UK exports) and £374 billion worth of imports (52% of all UK imports).
The reason that the outcome is so unpredictable, is the contradicting nature of goals: While the a successful deal may ensure a future trade relationship of close neighbours and allies, the prevalent question for all parties seems not to be whether that outcome is good for the economy, but whether they can “sell it” to an increasingly polarised internal audience. This is why negotiations were really always set to drag on and a deal, if any, would be reached under the pressure of the ticking clock. The world when the referendum was announced in 2015 is a different world than today, not least because of Brexit itself.
Mainstream, business-as-usual politics have been rejected by a large enough part of the electorate on both sides of the channel, rendering international coordination a more difficult enterprise. In this world, central bank monetary interventions, the lack of market-driven urgencies and the underwriting of an unprecedented amount of debt, may have caused moral hazard to spill into the world of politics. The retrenchment of multilateralism has also diminished the institutions and the forums which fostered that cooperation. Where in 2015 US President Barack Obama intervened directly to avert Grexit (Greece’s departure from the EMU and the EU), the US President in 2020 is taking a much more hands-off approach in relieving tensions between NATO allies.
These are the details that make history, and at this point we have very little insight as to how it will play out. What we have greater insight on is:
- Deadlines are important, but not absolute. Even if they completely break down now, negotiations might resume in January again, although the UK could very well be under increasing pressure from that point on.
- Last week, BoE Governor Andrew Bailey suggested that a no-deal Brexit would be worse for the economy than Covid-19. Given the size of the stimulus already in the economy, a definitive no-deal Brexit would probably mean much higher levels of debt, maybe followed by credit rating downgrades and a structurally weaker Pound.
- The world will probably be taking another turn towards multilateralism after 20th January (President-elect Joe Biden isn’t legally allowed to intervene anywhere until that time). Negotiations under that light might look different.
Even if the probability of a December cliff-edge Brexit grows by the day and the worst possible scenario materialises, there’s always a deal to be made at some point, before the economic damage becomes too pronounced. Long term investors should focus less on “when” and more on “whether” the deal will materialise, possibly considering the merits of tactical allocations on relatively distressed assets.