Brexit Market Challenges

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British Prime Minister Theresa May’s unenviable task of negotiating the British exit (Brexit) from the European Union (EU) has been dogged by challenges at every turn. However, the events of the past week may prove to be insurmountable for the beleaguered Prime Minister and ultimately lead to her downfall. In spite of the turbulence confronting her government, markets appear to be slightly optimistic about how the Brexit talks are developing.

The historic referendum of June 23, 2016 (wherein the peoples of the United Kingdom voted to withdraw from the EU) resulted in panic selling, as the FTSE 100 dropped approximately 3.15% and 2.55% on the two subsequent trading days, respectively. Nevertheless, whether because of a growing local economy, a recovering global economy, or belief that the British politicians could negotiate an advantageous withdrawal from the EU, the FTSE 100 rallied from a low of 5,982.20 after the vote to 7,692 as of July 10, 2018. The British pound depreciated in value over this time, falling from 1.4883 GBP/USD on June 23 to nearly 1.2 GBP/USD before finding support above 1.30 GBP/USD.

On March 29, 2017, the United Kingdom became the first member of the EU to trigger Article 50 of the Lisbon Treaty, a relatively new amendment to the original agreements signed by the EU member states that permitted and outlined, albeit vaguely, the process by which a state could withdraw from the EU. In order to navigate these unknown waters, Prime Minister Theresa May formed a government that included, amongst others, a number of pro-Brexit politicians.

One of the biggest uncertainties surrounding Brexit was the type of agreement that would be reached between the negotiating bodies. The following provides a simplified explanation of the major differences between the two approaches. A “soft Brexit,” also known as the “Norway Model,” would theoretically be the least disruptive on an economic level. In this scenario, the United Kingdom would participate in the single market created by the EU, but still be required to recognize the free movement of people from other member states of the EU within its borders. The alternative is the free trade model of the “hard Brexit,” referred to as the “Canada Model.” In this case, the United Kingdom would not be granted the free trade benefits of the single market, but would have greater control over immigration matters.

That brings us to the present. Operating under the belief that the Prime Minister was favoring a “soft Brexit,” three prominent members of Prime Minister May’s cabinet and two Tory party vice-chairs resigned in protest over the course of the week. Further threatening her standing was the specter of a “no confidence” vote being raised, although this threat appears to have subsided as the week progressed.

The fears of the Brexit hardliners were confirmed on July 12, when the Prime Minister released a “soft Brexit” proposal that she claimed had already been “cleared” by German Chancellor Angela Merkel, although there are doubts on both sides as to whether this is the case.Nevertheless, this development has opened the floor to a fresh wave of concern from both the opposition and members of the Prime Minister’s own party.

Further complicating the situation is President Trump’s visit to the UK at the end of the week. Although he had been a vocal proponent of Brexit, his critics fear that his administration may be seeking to take advantage of Britain’s increasingly isolated position to negotiate trade agreements that are heavily weighted in favor of the United States.

So how are markets reacting to these developments? As previously noted, investors have pushed British equities higher over the past two years, going so far as to set record highs. Although we can only speculate as to how much farther the UK’s bull market will run, some short-term volatility has driven the FTSE 100 down about 3% from its record high. Bullish investors might view this small margin as an opportunity to buy before the market continues its rally. Even last week’s short-term noise appears to have been more or less shrugged off, as the FTSE 100 turned positive going into the end of the week. On the other hand, bearish investors could point to the delicacy of the Brexit negotiations and the potential for an agreement that handicaps the British economy, Theresa May’s increasingly fragile position, or simply the rally exhausting itself and breaking below its support at roughly 7,500.

Given the delicate balancing act Britain faces, this will be a situation to monitor in the coming weeks, as new developments could have a significant impact on the valuation of British equities and the global capital markets as a whole.

Jeremy Soister
Associate Institutional Consultant

Source: Bloomberg


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