Jamie Stuttard, Head of Global Macro Fixed Income – Robeco,
- The simple message of “Get Brexit Done” has given the UK Conservative party its largest electoral majority since 1987 under Margaret Thatcher. Gains were particularly strong in Leave voting areas of the north of England, with substantial changes to the UK’s traditional political map, as historically Labour seats (the “red wall”) flipped blue.
- Nationally, this ends a period of heightened political uncertainty since Theresa May lost the Conservative majority in 2017. There is now no hung parliament, no need for deals with the Northern Irish DUP, no coalitions. There should be less drama in Westminster over the next five years than over the last three – or indeed the last nine.
- Voters rejected the message of the Liberal Democrats, to “revoke” the UK’s 2016 EU Referendum. The Lib Dems ended with just a dozen or so seats and their leader, Jo Swinson, lost her own. Since the EU’s creation, votes against it at national level (in Ireland, France and the Netherlands– on matters such as the Lisbon Treaty and European Constitution) have generally not had much political consequence, with anti-EU votes overturned, elections re-run or concerns simply brushed under the carpet. On Thursday night the UK has shown a democratic resilience at national level, paving the way for the 2016 referendum to have real political consequence. There is no prior precedent within the EU for this challenge to the EU’s top-down authority. This may or may not be a one off political phenomenon.
- The electorate also rejected the centralized power of the 1970s-style high tax and spend policies of Jeremy Corbyn’s Labour. Mr Corbyn will step down, the open question is whether Corbynism will survive. There is a long process of rebuild to come, in which the party’s future direction – of whether or not to abandon the recent hard left direction – remains unclear.
- The one note of future political uncertainty is in Scotland, where the SNP performed strongly amid a near complete Labour wipe out. This will heighten calls for a second Scottish referendum, after the initial rejection of independence in 2014.
- The UK now has a less uncertain landscape for investment, FDI, M&A and private sector spending for the first time since Q2 2017 when the hung parliament that has so dominated headlines, began. Until yesterday, large hikes in corporation tax, confiscation of shareholdings, nationalization of utilities and other key infrastructure – even possible financial crisis from unsustainable fiscal plans – were all possible. The tail risk of a return to 1970s economic dysfunction – which led to the UK’s 1976 IMF bailout – has been taken off the table.
- Still, the future trade uncertainty which developed since the 2016 Referendum remains in place. A UK exit from the EU on 31st January is, to paraphrase Churchill, only the “end of the beginning”. The natural protectionist leanings in some EU countries, and insecurity within Brussels that other countries might be encouraged by an economically successful UK departure argue for a hard EU stance to future trade. Arguments over regulatory alignment may also prove hard to resolve easily. A protracted wrangling will damage the growth potential of the bloc overall but it is probably the base case.
- These two conflicting drivers suggest a near-term bounce, but a contained longer-term growth trajectory versus potential until trade issues are resolved.
- The rise in GBP should keep inflation subdued and lead to a Bank of England (BoE) on hold. The BoE will likely have a new Governor early in 2020.
- The immediate reaction is positive for risk, with credit markets opening stronger, particularly in High Yield and Subordinated Financials. A relief rally (relief at the disappearance of the threat of higher corporation tax and an end to hung parliaments) can ensue. The starting point in credit is not particularly cheap as, in fairness, UK banks and other bellwether measures of UK credit risk premia have outperformed throughout 2019 after 2018’s volatility. Structural challenges in the bottom end of UK High Yield – in retail for example – are likely to remain.
- We expect the UK Gilt curve to bear steepen, with a rise in longer-dated Gilt yields as the Flight to Quality premia that was embedded in Government bonds subsides.
- The fiscal risk of Corbynism is taken off the table, but the new Johnson/Javid administration will be fiscally loose – very different to the nine years of Osborne and Hammond – which will mean increased supply.
- We think the front end should remain relatively anchored by low central bank rates.
- The currency can continue to strengthen. In the long-term, Sterling still trades significantly below its start of 2016 levels so there is very large ground that could in theory be recouped.
- Weighing against a recovery, the UK’s double deficit makes it a riskier currency. Still, with the recent fashion for increased fiscal spending – endorsed this week by Christine Lagarde at her first ECB meeting – it is perhaps the current account that matters more. On the latter, early signs (even pre-election) of an increase in FDI and M&A, particularly from sources of capital such as Hong Kong, could continue.