MPs reject Brexit deal

Theresa May’s proposed Brexit deal was rejected by parliament yesterday by 432 votes to 202. This was widely expected; going in to the vote bookmakers had quoted odds of less than 5% in favour of the vote passing. The margin by which the vote failed was, however, a surprise – the 230 vote margin of defeat is the largest any government has experienced in history. None of the political groups which had voiced objection to the deal shifted their views, despite May’s pressure tactics. 118 Conservative MPs as well as all 10 DUP MPs voted against the deal.

Opposition leader Jeremy Corbyn immediately called a vote of no confidence in the government, supported by other opposition leaders, which will take place this evening. Based on statements from Conservative and DUP MPs, it currently seems unlikely that this vote will pass. Theresa May has said she will start cross-party talks this week.

Initial market reaction has been positive for sterling. The pound is up 1.3% versus both the dollar and the euro. Equity markets are opening marginally higher in Europe and unchanged in the UK. Bond markets have opened on the back foot, with 10 year gilt yields 4 basis points higher. The reason for the positive reaction in the markets seems to be due to the size of the loss for the government. It puts the emphasis on parliament to get a deal and due to the composition of parliament, this would seem to reduce the probability of hard Brexit.

The key questions now are where do we go from here and what are the investment implications of the different scenarios? Thanks to last week’s amendment in parliament we won’t have long to find out – Theresa May now only has three days to bring an alternative plan to parliament, having lost a key vote sponsored by Conservative pro-remain rebels. This only gives the prime minister until 21^st January to come up with a plan B. At present, if there is no deal agreed by 21^st January, then the UK will leave the EU on 29^th March without a transition period. In addition, MPs have the power to amend any response, following another Commons defeat for the government in December.  Both of these amendments have seriously restricted the prime minister’s room to manoeuvre and make it very difficult to accurately predict an outcome.

Possible Outcomes

At this stage, all options are still on the table. However, despite the many possible political outcomes, there are fewer possible market reactions. The most immediate and significant asset price moves tend to be seen in the currency markets, i.e. the price of sterling versus other major global currencies. Hence, outcomes can broadly be divided between those that are sterling positive and those that are clearly sterling negative. Here we order potential outcomes from the most sterling positive to the most negative. The significant implications for other markets are also detailed below.

• May’s deal is passed in a slightly amended format. This scenario is now looking far less likely following the government’s comprehensive defeat last night. It is worth noting that up until the vote this option was the base case for many of the investment banks. If this option does in fact come to pass, sterling could rally strongly due to it having the advantage of causing the least market uncertainty.


• Parliament comes up with a new plan and approaches the EU for an extension to renegotiate, giving the UK more time to agree an orderly exit. This option looks more likely following the vote and recent parliamentary amendments. If a new plan is closer to the Labour vision of Brexit, i.e. closer to the Norway model, it could well command cross-party support. It is also not clear whether it would be Theresa May’s government who would lead renegotiations in this scenario and is clearly dependent upon the outcome of today’s vote of no confidence. The major difficulty with this option is whether the EU will be willing to extend the deadline or renegotiate. So far EU officials have made it clear that the deal on the table is the only one available. Furthermore, EU parliamentary elections will take place in May and if the UK is still a member of the EU by this point it raises a lot of difficult questions as to whether the UK should be represented in these elections.


• A new referendum. The favoured option by many pro-remainers but so far the movement to enable this in parliament has not gained significant momentum. The two key issues here are whether the Labour leadership will now favour this option, Corbyn has thus far been publically reluctant, and what question would be asked on the ballot paper. In this scenario sterling is likely to rally in the short-term and then be liable to temper based on what direction opinion polls take.


• A general election. A new election is the stated policy of the Labour party, but relies on Theresa May being ousted in today’s no confidence vote, and no alternative government emerging. As mentioned above, we find the probability of this being passed unlikely. Markets and sterling will likely react negatively here, as the risk of a Corbyn government increases significantly, which is perceived by most as significantly sterling and equity negative.


• A ‘No-Deal’ Brexit. Although parliament has already voted against a ‘no-deal’ Brexit, this may be the default option if they cannot agree an alternative solution or if the EU refuses to extend or renegotiate. Clearly this is the most negative scenario for markets, as multiple studies have shown the risk to long term economic growth in the UK under this scenario. The Bank of England economic analysis shows a GDP shortfall of 4.75% by 2023 under a “disruptive no-deal Brexit” and a shortfall of 7.75% under a “disorderly no-deal Brexit”.

Investment Implications

If an amended deal is passed by parliament it would clearly be sterling positive – scenarios range from a 10% to 20% gain versus the Euro – but it would also have major implications for other asset classes. Bond yields are likely to rise, as the Bank of England has made it clear that once Brexit uncertainties have passed they plan to continue raising interest rates, especially if economic fundamentals improve. This will be negative for long-dated gilt holdings. Credit spreads are also likely to tighten as company fundamentals improve and therefore we would expect corporate bond funds to outperform gilts in this scenario.

In the equity markets the picture is less clear. Other international equity markets are currently being driven by more global factors, in particular the US/China ‘Trade War’ and the actions of the US Federal Reserve. Returning to the UK, FTSE 100 companies have a strong reliance on overseas earnings, and therefore the weaker pound has boosted earnings figures since the referendum. A surging pound may reverse this, but equities will most likely benefit from the overall positive sentiment. The FTSE 100 has underperformed other global equity indices since the referendum and this may start to reverse once we have clarity. For domestic focused UK equities, and in particular most FTSE 250 companies, any deal will be a clear positive.

The opposite is to be expected in a ‘no-deal’ scenario. We would expect sterling to drop strongly, bond yields should fall (as talk of a Bank of England rates cut will emerge), credit spreads should widen and domestic UK equities will most likely underperform. A Corbyn government would most likely lead to such similar outcomes, except that bond yields could rise due to Labour’s plans to meaningfully increase government borrowing.

Given the significant tail-risk, which cannot be ruled out, we continue to advocate a cautious stance through lower equity weightings and higher cash levels ahead of any resolution.

Robet Van Kleeck

Senior Fund Manager

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