All eyes on upcoming Brexit votes – weekly update 11 March

Brexit – crunch week?

After a bit of a lull, the Brexit politics re-intensify this week as the deadline looms at the end of the month. Whilst some may see this as the end-game, in reality I think we’re more likely to see a phase-change than substantial progress. There is still the chance that Tuesday’s vote is pulled at the last moment, but as it stands we are expecting a potential series of votes – below is our interpretation and the key considerations around each one.

Tuesday 12 March – The Prime Minister’s Deal

Expected to be presented for a second time with no material change, the Government’s political gambit of running down the clock appears to have failed. The hope was that the Attorney General could secure enough wiggle room to alter the legal advice to avoid the potential of being trapped into a Customs Union. Instead, there is political paralysis of the key players’ own making: the EU is unwilling to make any concessions, at least in part because from their point of view there is little confidence that the PM can get the deal approved.

Conversely, despite some rhetorical softening from the pro-Brexit European Research Group within the Conservative Party, absent any concessions at all from the EU, the rebels have no political cover to vote for the deal even if they now wanted to (to avoid the potential consequences, including the delay or abandonment of Brexit at all). Frantic negotiations both with the EU and within parliament will no doubt continue until the last possible minute, but the withdrawal agreement certainly looks to be in serious peril.

• Approval – Whilst the deal splits opinion and pleases rather few overall, accepting the deal would provide some certainty on a path forward, and could be used as a starting point for further negotiation. At this stage, even approving would probably require the request of a short, ‘technical’ extension to finalise the rules and procedures embedded in the agreement.
• Rejection – The more likely outcome, which probably sees the final end to the deal, and a pivot by the Government to a new policy. As it currently stands, this would result in the second proposed vote (see next).

Wednesday 13th – No Deal

The only apparent consensus in parliament is against leaving without a deal, with the indication that even those arguing for a ‘no deal’ scenario mostly want it simply for leverage in the negotiations rather than an end in itself. At this stage is seems unlikely to pass, but stranger things have happened.

• Approval – This most unlikely outcome nevertheless provides the most short-term certainty, with the UK falling out of the EU effectively onto World Trade Organisation rules on 29 March, given that no other trade deals have yet been concluded. This would be a shock outcome, and would likely hit sterling hard.
• Rejection – The assumed outcome of any no-deal vote would confirm that a no-deal outcome is not credible, and pave the way for the final vote of the series.

Thursday 14 March – Extension to Article 50

With the only deal on the table rejected, and parliament voting against ‘no deal’, the only logical outcome is for Article 50 to be extended to provide more time in order to overcome the current impasse. Of course, parliament is not required to act logically and so whilst accepting a vote on extension currently seems the most likely outcome, it is also far from certain, and comes with its own set of complications.

• Approval – The most likely end-point would see the Government request an extension to the Article 50 declaration. However, it remains down to the EU whether to offer such an extension and, crucially, the terms of any extension. Expect these negotiations to be as tough as any other Brexit-related negotiation, with the length of the extension, any additional payment considerations, restrictions on third party trade negotiations and more all likely to be up for debate. Added to this, the next round of European Parliament elections are scheduled for May, adding an electoral complication.
• Rejection – It is conceivable that parliament opts for the triple-no outcome, and complete Parliamentary deadlock. In this scenario, despite rejecting the earlier vote, a no-deal exit is back to being the default outcome.

Whilst the votes this week are designed to bring some clarity as to the path the Government takes, each outcome in and of itself brings further complications. As it stands, the most likely outcome is the Government seeks an extension to Article 50, though it is still possible that the Prime Minster finds a way to rescue her deal. Finally, whilst no-deal is generally considered to be undesirable, it remains the default pathway.

The latest from the European Central Bank

Faced with heavy cuts to the economic outlook for the Eurozone, the European Central Bank (ECB) provided further monetary accommodation. Full-year GDP growth expectations were slashed to 1.1% down from a forecast of 1.7% made just in December, whilst inflation expectations were revised down from 1.6% to 1.2% for 2019.

This speaks to the broader malaise we have seen (and spoken about) in the Eurozone over recent months, and highlighted by comments by the ECB President, Mario Draghi, in the press conference that the region was “in a period of continued weakness and pervasive uncertainty”. In response to this, the ECB pushed out its forward guidance, announcing that there would be no hike for the rest of the year – a point already priced into the market but it is nevertheless informative that the ECB effectively endorses the market view.

More of a surprise was the announcement that the ECB would offer new, cheap loans to Eurozone banks. The fresh Targeted Longer-Term Refinancing Operations (TLTRO) scheme should allow banks to roll-over their cheap funding from the previous incarnation, staving off a liquidity squeeze rather than providing additional stimulus. As a result, fresh TLRTOs had been expected, but last week’s announcement was more prompt than people had been anticipating. Despite announcing the new loans, the Central Bank left itself some flexibility around the details, but signalled there would be incentive provisions which will presumably encourage the region’s banking system to promote loans to the real economy. Although the stimulus would ordinarily promote positive sentiment, the significantly deteriorating economic backdrop has prompted some to wonder whether it will be enough to restore meaningful economic growth.

US labour market report

The US labour market report ruffled a few feathers, but the big miss on the headline reading obscured what were strong fundamentals below the surface. The first look at headline Non-Farm Payrolls showed just 20,000 jobs added in February, a long way below the 180,000 expected, but this does come after an outsized 311,000 jobs added in January – so despite raising a few eyebrows, the reading has little impact on the economic outlook.

As usual, the wage data were more interesting, and here we saw average hourly earnings rise from 3.1% to 3.4% year on year (yoy), ahead of the 3.3% expected and a fresh post-Global Financial Crisis high. Unemployment fell to 3.8% now that the government shutdown is out of the data, whilst underemployment fell to 7.3%. So overall, a pretty robust report, once you get past the first line.

Last week’s other events

• China has set a new, lower target range for GDP growth. At the National People’s Congress, Premier Li Keqiang announced that 2019 GDP was expected to come in between 6-6.5%, down from the more precise 6.5% that has been the target for the last two years. This comes as the world’s second-largest economy tries to manage its slowdown as well as dealing with a trade war with the US – signs of the pressure being caused by the latter were seen in the latest trade data (for February), which showed that exports were down -20.7% compared to a year earlier in US dollar terms (imports were down -5.2%). The Composite PMI reading from Caixin fell from 50.9 to 50.7 following a disappointing Services reading
• The UK Composite PMI reading unexpectedly bounced up to 51.5 from 50.3 (50.1 had been expected), buoyed by a strong recovery in the Services measure. However, Construction PMI slipped into contractionary territory, down to 49.5 from 50.6 (50.5 was expected)
• In Japan, the Composite PMI reading slipped from 50.9 to 50.7. Labor Cash Earnings growth moderated from 1.8% to 1.2% yoy, and Bank Lending (excluding Trusts) held steady at 2.4% yoy. The Eco Watchers Survey showed an improvement in the current conditions measure from 45.6 to 47.5, but a deterioration in the outlook from 49.4 to 48.9

The markets

The New Year rally finally petered out last week, and skittish markets took a little fright, pushing equities down and core sovereign bonds up (reducing yields).

One-month performance of major asset classes in sterling terms

Equities

Equity markets gave up a bit of their recent strength last week. The UK was actually the strongest performer of the markets we report here, mitigating losses to -0.1%. Continental European equities were down -1.0% and the US market fell -2.2% for the week. Japanese equities were down -2.6% whilst Emerging Markets returned -1.5% (all indices are MSCI).

Bonds

As equity markets fell, core sovereign bonds rallied. 10-year US Treasury yields fell 12 basis points (bps) to finish at 2.63%, 10-year UK gilt yields were down 11 bps to 1.19% whilst the equivalent German bund yields were also down 11 bps to yield just 0.07% on Friday.

Commodities

Gold rebounded on Friday, but remains below the US$1,300 mark, finishing at US$1,298 per ounce by the end of the week. Oil was little changed overall, with Brent Crude closing at US$65.74 per barrel, whilst copper was weaker at US$2.89 per lb.

Currencies

Sterling and the euro were weaker overall, with the pound softening -1.4% against the US dollar. Sterling closed on Friday at US$1.30, €1.16 and ¥145.

The week ahead

There are a few data points of interest this week, while the real focus will most likely be on the UK political front as the latest, 11th hour round of Brexit voting is due (see above). For the data side, US Retail Sales on Monday could be informative (0.6% from -0.1% month on month/mom, expected on the Control Group). Tuesday gives us UK Industrial Production in the morning (-1.3% from -0.9% yoy expected) and the afternoon has US CPI due out (no change at 1.6% yoy expected). Wednesday has Eurozone Industrial Production in the morning (-2.1% from -4.2% expected) and US Durable Goods in the afternoon. Thursday will see the latest data dump from China (Industrial Production, Retail Sales and Fixed Asset Investment especially). Seeing out the week, on Friday US Industrial Production is reported (0.4% from -0.6% mom expected) and the Bank of Japan concludes its latest monetary policy meeting (no change expected). The daily breakdown is as follows:

Monday: Early in the morning (UK time) Japan reports Machine Tool Orders, and in the afternoon the Retail Sales numbers will be the highlight (covered above).

Tuesday: UK industrial production and US CPI are the main prints of the day (covered above), though there will also be the US NFIB Small Business Optimism report to analyse. Later in the evening, Japan will report Core Machine Orders. In the UK, all eyes will likely be on the latest developments on the Withdrawal Bill, assuming it goes ahead.

Wednesday: Eurozone Industrial Production and US Durable Goods are the main data releases to study – for the latter, forecasts suggest a -0.5% mom contraction.

Thursday: For the Chinese data batch release, expectations are for a pick-up in Fixed Assets investment from 5.9% to 6.1% yoy (year-to-date), but for cooling in both Industrial Production (5.6% from 6.2% yoy) and Retail Sales (8.2% from 9.0%). Elsewhere, US Import and Export prices data are released.

Friday: In addition to the Bank of Japan monetary policy meeting and US Industrial Production, we also have the Empire Manufacturing Index report and the latest survey results from the University of Michigan, assessing sentiment and expectations.