For Brexit, the Only Certainty Is More Uncertainty

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By Joyce Huang - March 14, 2019

U.K. policymakers cast three Brexit votes this week. Yet, the terms governing the U.K.’s exit from the European Union (EU) remain unclear, creating continued uncertainty for investors.  

The U.K. bond market’s reaction has been muted, with the yields on the 10-year and two-year U.K. government bonds remaining steady near 1.20% and 0.75%, respectively. The British pound strengthened to a nearly two-year high versus the euro, but some of this likely reflects the recent dovish stance from the European Central Bank.

Latest Votes Yield More Confusion

Early in the week, Prime Minister Theresa May suffered her second Brexit-related defeat. Parliament once again rejected the divorce deal she negotiated with the EU. On the following day, policymakers took a no-deal Brexit off the table, throwing Prime Minister May’s plan and the March 29 exit deadline into confusion.

The vote rejecting a no-deal Brexit reduces the prospect of a chaotic departure—a worst-case-scenario for businesses, investors and the U.K. economy. However, the vote is not legally binding, leaving Prime Minister May with the option to continue running down the clock to a no-deal default on March 29. That option seems unlikely, though, given Parliament voted Thursday to extend the Brexit deadline for at least three months. But the new June 30 deadline applies only if policymakers agree to the prime minister’s exit proposal by March 20.

What’s more, the other 27 EU members must unanimously approve any Brexit extension. If Parliament passes a deal next week, it’s likely the EU will grant the three-month extension, giving all parties time to implement the plan. If U.K. policymakers fail to reach an exit agreement, the British government must obtain EU approval to extend the deadline further. Under this scenario, EU member nations will vote on the Brexit extension at a summit that begins March 21. A rejection from the EU likely would trigger a no-deal Brexit, effective on the original, legally binding March 29 deadline. And even if the EU agrees to an extension, it can impose restrictions around the new exit date.

Deadline Extension Opens Door to New Referendum

Extending the U.K.’s departure deadline beyond March 29 also opens the possibility of a second referendum on Brexit. It remains unclear, though, whether voters would overturn the original June 2016 referendum that set in motion the U.K.’s exit from the EU.

As we’ve witnessed over the last several months, securing a departure deal that satisfies all the competing factions is a momentous challenge. Among considerable fallout, the process has led to heightened market volatility and widespread uncertainty for businesses and investors. Although policymakers likely will extend the departure deadline, it remains unclear whether they will use this time to continue negotiating a deal, prepare for a no-deal exit (not legally ruled out) or announce a second referendum.

Portfolios Prepared for Brexit Outcomes

In response to ongoing Brexit-related uncertainty and volatility, our fixed-income portfolio managers have reduced exposure to risk in the U.K. and Europe. Specifically, we are avoiding U.K. and European corporate bonds with close ties to Brexit-related volatility, including select holdings in the industrial and financial sectors. Even if policymakers secure a deal and a smooth separation with the EU, we believe a rally among corporate bonds remains unlikely. Therefore, we currently don’t see much value in U.K. credit sectors.

As always, we continue to base our investments on fundamental factors. For example, we’re maintaining short positions in U.K. and European interest rates, which remain unusually low. The difference in rates between the U.S. and the U.K. and Europe is historically wide. We believe our short position would benefit from a smooth Brexit, as U.K. and European rates likely would rise.

Overall, though, we don’t believe any potential Brexit outcomes will have a dramatic effect on our U.K. and European holdings. Until the uncertainty fades, volatility likely will remain heightened, underscoring the need for engaged investment management to avoid pitfalls and uncover opportunities.

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Joyce Huang, CFA
Joyce Huang, CFA
Sr. Client Portfolio Manager
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      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

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