Richard Flax, Chief Investment Officer, Moneyfarm
After months and months of nothing to report, we finally have a flurry of activity in the UK. We have a new Prime Minister, we have a new cabinet, and the probability of a No Deal Brexit seems to have risen sharply.
We continue to believe that a No Deal Brexit will be negative for UK growth and for a number of UK sectors. The question is, how likely is that to happen? That’s still unclear. The Prime Minister is talking an aggressive game, perhaps to kick-start negotiations with the EU.
There’s an old line that says the politicians campaign in poetry but govern in prose. We can certainly say that Boris Johnson campaigned in poetry, but so far he seems to be doing the same thing in government.
Now, some of that is clearly for the benefit of his domestic audience and also perhaps for the audience in the European Union, but at some point that poetry has to translate into proposals.
So far, the EU is sticking to its guns; there’s no deal but the one on the table, the backstop is sacred, and we really don’t have much room to manoeuvre. Once all the initial noise has quietened down, we’ll see if this is the whole truth, but we have to recognise that after a couple of years of negotiations, there simply may not be an alternative to what is on the table.
The UK government will then have a decision to make, does it back down or really take this to a No Deal on 31 October.
What does this mean for financial markets?
We expect we’ll see downgrades to GDP growth in the UK and perhaps to a lesser extent in parts of the eurozone.
We’ve already seen sterling slide in the last couple of weeks, with the pound weakening, particularly against the dollar. Over the last couple of years, the uncertainty around Brexit has weighed particularly on business sentiment and business investment. The severity of the impact varies by sector, but overall, the trend is down.
From a markets perspective, there are a couple of implications. The FTSE 100, the large-cap UK equities index, has a significant global exposure – over 70% of its revenues come from overseas. This means it’s a relatively good hedge, up to a point at least, against sterling weakness.
The mid-cap space, middle-sized companies that are listed, are a bit more domestically focused and we’d argue it’s here that you see greater risk to earnings, corporate profitability, and perhaps to valuation.
Boris Johnson has been dismissed as a number of things: ill disciplined, lacking in attention to detail, and unserious – and these are criticisms that have been levelled at him throughout his career, even as he’s climbed the greasy pole of politics to Number 10 Downing Street.
We should also remember though, firstly, that he’s had significant staying power in the face of a number of setbacks over the years and, secondly, he’s not alone. He has a number of advisors, a number of supporters, a number of colleagues who have both the brainpower, the discipline and the focus to drive the UK towards their preferred outcome, be it a new negotiated settlement or a No Deal Brexit.
Why bond market is more interesting
The bond market is maybe more interesting. In the event of no deal, we’d expect to see bond yields fall, driven by concerns about UK growth.
We expect to see government spending increase to try and offset some of the impact of No Deal. The Bank of England is also likely to make sure that financial stability is maintained and that there’s sufficient liquidity in the system. Overall, however, over the next 12-18 months, in the event of no deal we’d expect those yields to decline.
Fed cuts rates
It might surprise some to see there’s more going on in financial markets than just Brexit. This week the Federal Reserve cut interest rates for the first time since the Great Recession, although the Central Bank took pains to point out that in their view this was just a mid-cycle adjustment, rather than the start of something more meaningful. That left financial markets feeling a little uncertain.
At Moneyfarm, we expect to see another 25-50 basis point cut from the Federal Reserve over the next six to nine months, but not much more than that.
The US economy, although it has slowed a little bit, remains relatively healthy, particularly on the employment side and a couple of interest rate cuts should be enough to ensure the long, slow expansion that we’ve seen, the longest on record, is able to continue.