The week ahead: Brexit debates, PMIs and yield watch

As we start a new week in the UK, the focus is on the renewed Brexit debate, which has resurfaced after some assumed it was put to bed at the end of 2020. The Sunday Times ran a story that said senior government figures were mulling over putting Britain on the path towards a Swiss style relationship with the EU. In effect this would mean frictionless trade, but it would come with a price: free movement and contributions to the EU budget. However, those claims have been rebuffed by PM Rishi Sunak on Monday, he told the CBI conference that he would not support a realignment with EU trade rules although he would be looking for closer ties with the EU. The Brexit debate has resurfaced at an interesting time for the UK. The latest YouGov polls suggest that the wider British public now think that Britain was wrong to leave the European Union by 56% to 32%, and one fifth of Brexit voters now think that they made the wrong decision. The ERG was outraged by the headlines on Sunday and vowed to bring down the government if they planned on following a Swiss-style relationship with the EU. However, it appears that public support for Brexit is waning, so what does this mean for the future relationship between the UK and the EU, and for UK asset prices? 

The problems of a Swiss-style relationship with the EU 

Even die-hard Remainers like myself, would be wary of a Swiss-style deal. While I would welcome re-entry to the single market, the Swiss don’t have a say at the EU table, for the UK’s best future interests, surely, we need to forge stronger ties with the EU. What is interesting, is that if YouGov is correct, and if one fifth of Brexit voters now think they made the wrong choice in 2016, then if there is a re-run of the Brexit referendum then the UK would overwhelmingly vote to remain in the EU. This should give Rishi Sunak and co. pause for thought. The unplanned, chaotic, and ugly Brexit that was delivered by Boris Johnson is not working for the country and the voters know it, thus I would very much expect that behind the scenes the government is working on building a strong relationship with the EU. Here at Minerva, we would urge the government to do something bigger and bolder than replicating a Swiss-style relationship. Of course, Sunak can’t yet speak about this out loud. But soon, even the ERG will know that the game is up and when that happens, hopefully Brexit will be confined to history as a bad mistake, found in the same bracket as the Liz Truss premiership. 

The UK’s continuing debt problem 

The impact on UK asset prices is more nuanced, but overall, I believe that signs that the UK and EU are building stronger bonds will have a positive impact on UK asset prices. At the start of the week, there is a risk off tone to global markets, European and US stocks are lower, while the Vix index, Wall Street’s fear monitor, is up. Likewise, the dollar has also caught a bid on Monday and is the strongest performer in the G10 at the start of this week. Government bond yields are lower across the board, however, after last week’s spike higher, UK Gilts are one of the strongest performers in the G10 sovereign bond space at the start of this week. After the UK’s Autumn statement at the end of last week, 10-year Gilt yields surged by 20 basis points. This followed on from the backloading of UK government spending cuts announced by Jeremy Hunt. Added to this, a report by Citi pointed out the total amount of government debt that the Treasury will have to issue in the next two years. In recent years, the BOE has been buying up lots of government debt, but now that it wants to shrink its balance sheet it won’t be the buyer of last resort that it once was. It is worth noting that the biggest buyer of UK Gilts in the 3–7-year range is now a seller. This leads to the question – who will buy UK government debt, especially when the growth outlook is so bad? The fact that Gilt yields have fallen on Monday is telling: the prospect of a closer relationship with the EU, even an imperfect one like a Swiss-style deal, is pleasing to the bond market and could entice more buyers of Gilts in the coming years. The government and Treasury know this, and it is why we believe that within 2 years the UK’s current relationship with the EU will have to change. Within 5 years we could even be back in the EU. Being part of a large trading bloc, boosting growth and having the safety of being in a club with like-minded democracies could help sell UK gilts in the coming years. We can’t afford not to change our relationship with the EU, and even some Brexit-voters are coming to this conclusion. 

A stock picker’s market 

Elsewhere, the oil price collapsed at one stage on Monday, and Brent crude fell more than 5% to $82.99. This is down to two factors, firstly, that Opec were considering oil production hikes and secondly, reports that China has not shifted its zero covid stance and locked down another region after 3 covid deaths. Covid cases are surging in China and Hong Kong and there are rumours that hospitals are filling up in HK. This could delay the great “reopening trade” in China, which helped boost overall market sentiment in recent weeks. However, the Brent crude price rallied late in Monday’s session after sources from Saudi Arabia said that Opec would not consider production hikes any time soon. As we have said for some time, this is a tricky time to trade and it is a stock pickers market, as there are still big risks to general market sentiment. The Walt Disney Company’s share price has surged by near 7% on Monday on news that Bob Iger, the former CEO is returning to the role. The share price is still at a 2-year low, after a slew of poor results, however the new/ old blood has given hope to shareholders that he can turn things around and return to the good old days of his tenure from 2005- 2020, when the share price soared. Iger will stay in the role for 2 years until a permenant replacement is found. 

PMI reports and the Fed pivot 

Global preliminary PMI reports for November will be parsed this week to see how bad the growth retraction is as we move towards the end of the year, and also for signs that inflation pressure is easing, particularly in the US. Fed members including Mary Daly, said on Monday that inflation is still a concern. This highlights the fact that the Fed is still far from a pivot. While the pace of rate hikes may slow this year, there will not be a true pivot until the Fed either stops rate hikes or starts to cut rates, we think that we will need to wait until the back end of 2023 for that to happen due to the expected stickiness of inflation. Thus, if this week’s PMI reports signal weak growth and high inflation, it could be bad news for risk sentiment and stocks.