Where Brexit Stands, and Where It May Go From Here
On October 4, we provided a brief summary of the Brexit negotiations — the talks between the UK and the European Union over how the UK will depart the EU, following a referendum of its citizens in 2016. Brexit fears have been one psychological driver of the current correction and have contributed to the markets’ grim assessment about weakening global growth prospects in 2019. There has even been nebulous fear that unforeseen Brexit consequences could result in a crisis and a recession.
As we have often written, we are ultimately bullish on the UK should it manage a Brexit worthy of the name — i.e., a Brexit that does not oblige the UK to continue to observe most of the EU rules the British thought they were rejecting. It remains to be seen if that will be achieved. In the meantime, though, the psychological significance of the Brexit process means that market participants navigating the current correction should stay abreast of current developments.
Where Do Things Stand?
Last week, two and half years after the UK vote that started the process, UK Prime Minister Teresa May handed her cabinet ministers a 585-page document agreed on between the UK negotiators and their EU counterparts. It prompted two immediate resignations — including the resignation of Dominic Raab, the minister who had been overseeing the negotiations. But mostly, her cabinet backed the proposed deal.
What exactly is this deal? Given how difficult it’s been to reach, and how long it is, you’d be forgiven for thinking that it was the final, complete agreement for the future relationship between the UK and the EU. It isn’t. It’s simply the “separation agreement” — not an agreement about future relations. It has three parts: a financial settlement (to cover the UK’s outstanding financial commitments to the EU), an agreement on the rights of European citizens in the UK, and UK citizens in the EU; and a mechanism to prevent a “hard border” with customs checks on the island of Ireland (i.e., between Northern Ireland, governed by the UK, and the Republic of Ireland).
Almost all of the trouble has come with that last piece — figuring out how the UK can leave the EU’s customs union, and still have no need for border and customs checks between Northern Ireland and the Republic.
This arcane issue is sticky because of Ireland’s fraught history, and the insistence of Northern Irish loyalists in May’s government that Northern Ireland not be treated differently from the rest of the UK — and that the North not be unduly separated from the Republic. The stability of May’s government depends on a Northern Irish political party, the DUP. So the draft agreement includes ALL of the UK in a customs union with the EU — and for the EU, that in turn means that the UK has to abide by a swath of EU rules on state aid, competition, the environment, labor conditions, and so on. This is exactly what the pro-Brexit camp did not want to see.
So for various reasons, there are many, many British politicians — Conservatives, Labor, and others — who vehemently dislike the deal that’s being proposed to them. After EU member states sign off on the deal in late November, the British Parliament will have to vote on it, probably in early December, and this will constitute the biggest test of Teresa May’s career. The parliamentary math is difficult and uncertain — in other words, it is far from obvious that the proposed deal will get approved.
Where Are Things Headed?
So what are the possible outcomes in the near future? We see several.
First, the draft agreement might be approved by the UK Parliament. This would be the most calming event for market psychology. It would also give great relief to UK and EU businesses.
Second, the draft agreement might be rejected. If it is, the Prime Minister has 21 days to put forward a new plan. However, in the meantime, this could trigger a vote of no confidence from her own parliamentarians, and then a new Prime Minister would need to be selected from among their ranks. Another kind of no confidence vote, from parliament as a whole, could trigger snap elections, which under current polling would be likely to bring a Labor government to power. Since the Labor Party is currently headed by hard-left socialist Jeremy Corbyn, this is not anything that Conservatives would want to risk — and so is unlikely. The defeat of the proposed deal in Parliament would lead to significant volatility and anxiety.
Third, Prime Minister May could withdraw the current agreement before a vote, to try to renegotiate, if it looks certain to be rejected. This would create less turbulence than a loss, but it also might trigger a Conservative leadership crisis or a push for snap elections. The EU negotiators are also likely to be uncooperative; they’ve been publicizing this as a “take it or leave it” offer.
Fourth, in the face of likely parliamentary defeat, May could ask the EU for an extension. This would be problematic, because of the tough stance taken by many EU members who wouldn’t want to cut the UK any slack. Some of them are battling political factions in their own countries who advocate ditching the Union — and they don’t want to make the process look pretty or easy.
Market implications: Watch for the results of the UK Parliament’s vote on the proposed Brexit deal — probably in early December. The results of that vote could have a significant effect on market psychology in Europe and in the U.S. The optimal outcome would be a win for the deal. A failure could cause further volatility — especially if Teresa May’s leadership, or Conservative Party rule, come into question.
