Deadlock Dooms Brexit Vote, Again

By Joyce Huang, CFA - January 17, 2019

All eyes were on the United Kingdom this week. U.K. Prime Minister Theresa May failed to usher her Brexit deal through Parliament for the second time in five weeks. She also survived a second no-confidence showdown.

The prime minister previously postponed a key Dec. 11, 2018 vote, fearing Parliament would reject the Brexit deal she sealed with the European Union (EU). The plan keeps the U.K. closely bound to the EU after the U.K. leaves the bloc—a provision many in the Conservative party reject. The postponement triggered the prime minister’s Conservative Party peers to hold a no-confidence vote, which she survived.

Parliament finally voted on the Brexit measure Jan. 15, and, as expected, lawmakers rejected the plan, but by an unexpectedly large margin. This led to another no-confidence faceoff, this time with all Parliament members voting. Once again, the prime minister persevered.

How the UK Got Here

In June 2016, U.K. voters approved a measure for the U.K. to leave the 28-member EU. Nine months later, Prime Minister May invoked Article 50 of the Lisbon Treaty, giving the U.K. and EU two years to hash out an exit agreement. That two-year period ends March 29, 2019 when the U.K. is slated to officially leave the EU.

The problem largely rests with politics. The Brexit referendum never outlined terms under which the U.K. would leave the EU. The politicians have that task, and their competing interests and views are wreaking havoc on the process. Prime Minister May negotiated a separation agreement with the EU in late November, but more than one-third of her own party members don’t support that deal. And it’s unlikely the opposition parties in Parliament will support any deal the prime minister brings to the table.

Deal or No Deal?

The scale of the recent defeat reflects the current Brexit deal’s unpopularity with all sides. And Prime Minister May’s ability to survive two no-confidence votes suggests that Brexit itself is the issue, not her. It seems unlikely the EU will approve a material overhaul of the negotiated deal. In fact, it remains unclear what changes would be necessary to satisfy all competing interests and receive Parliament’s approval.

The process remains highly contentious, leaving several options on the table. Lawmakers remain divided over which path to take. Their choices include exiting the EU without a deal, supporting Prime Minister May’s plan, holding a second Brexit referendum, or extending negotiations and the U.K.’s exit date. Currently, most observers believe extending the March 29 deadline will be the likely outcome. The odds of a no-deal Brexit seem to be shrinking. In this scenario, the U.K. would leave the EU on March 29 without any trade agreements in place. This outcome would likely be disruptive for businesses and put investors on edge.

We’ll learn more next week when Prime Minister May presents a “plan B” to Parliament. Lawmakers will have an opportunity to amend her proposal and present their ideas for an exit plan. While it’s unlikely this process will immediately lead to an agreement, it may serve to define the competing positions and pave the way for a compromise. The next Brexit vote is scheduled for Jan. 29.

Unpredictable Outcome Unnerves Markets

Brexit continues to be an enigma for financial markets. For example, despite the “no” vote on the prime minister’s plan, the U.K. pound appreciated and U.K. government bond yields declined. The next steps remain unpredictable and fraught with political nuances. Accordingly, we expect volatility to remain heightened in U.K., European and U.S. financial markets until lawmakers reach a clear resolution.

We are taking a cautious approach in U.K. credit markets, given the uncertainty and negative economic implications of a no-deal Brexit. Even if policymakers secure a positive outcome, including Brexit with a deal and a smooth separation with the EU, we believe it’s unlikely to trigger a rally among corporate bonds. Therefore, we don’t see much value in U.K. credit sectors going into 2019.

Regarding rates, we also remain somewhat cautious. Brexit with a deal or no Brexit at all (only a possibility if there’s a second referendum) likely would drive U.K. rates higher. However, with a no-deal Brexit, the Bank of England probably would cut interest rates to mitigate the negative economic impact.

Just as Brexit uncertainty was a prominent theme throughout 2018, we believe it will remain a formidable force in 2019. Volatility likely will remain heightened, underscoring the need for active investment management to avoid pitfalls and uncover opportunities.

Joyce Huang, CFA
Joyce Huang, CFA
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