WHAT TO WATCH: Tory Leader Contest Adds to Brexit Uncertainty
(Bloomberg) -- Market sentiment and the outlook for the U.K.’s relationship with the EU is closely linked to the fate of the five candidates bidding to replace David Cameron as PM.
- Pound falls a fourth day to trade just above post-Brexit vote lows vs dollar after BOE’s Carney signaled policy may be eased in the months ahead
WHO’S WHO AND WHAT’S THE LIKELY OUTCOME?
- Theresa May reluctantly supported staying in EU, delivering only one major speech during the referendum campaign; she is the favorite to win, according to bookmaker odds
- Backer Philip Hammond says the country needs to retain as much access to EU as it possibly can, minimizing any damage to the economy
- Her desire to delay the article 50 trigger may be later than EU leaders would like and could cause tension into year-end, Barclays analysts say
- Andrea Leadsom backed Brexit; she criticized BOE Governor Carney’s interventions ahead of the referendum
- Betting odds have her in second place; a YouGov poll puts May 32 points ahead of Leadsom in the final round
- Leadsom intends to keep negotiations as short as possible but didn’t put a deadline on when she’ll kick off talks
- UniCredit analyst Erik Nielsen says if she prioritizes limiting free movement of people that could send the U.K. into a WTO-only world
- Michael Gove was part of the “leave” campaign alongside former Mayor of London Boris Johnson; Johnson decided not to stand for the top job in the Tory party with some commentators suggesting Gove’s decision to stand was a betrayal of his former running mate; Johnson now backs Leadsom
- Stephen Crabb has urged caution on starting Brexit talks while Liam Fox was more specific on the timing of any exit, saying he would like U.K. to leave the EU on January 1, 2019, which would mean activating the Article 50 process by the end of this year
- BofAML analysts point out politicians have been clear they accept the result of the vote, but the analysts add a caveat were the economic fallout from the referendum to be significant
- Eurasia analysts Charles Lichfield and Mujtaba Rahman say a fresh vote isn’t their base case
- An election would only likely come about if the govt called for a vote of no confidence asking its own MPs to support the motion, they say
- U.K.’s access to non-EU markets will become markedly more constrained following Brexit for a period of years as non-EU trading partners may want to wait to see the detail of the country’s deal with the EU; any “quick” deals are unlikely to be on terms that are advantageous to the country, JPM says
WHAT’S NEXT?
- July 5: First Conservative MP ballot to whittle candidate list down to two; ballots continue on Tuesdays and Thursdays
- Conservative Party membership ballot may take place in August, if hasn’t already begun in July
- Sept 9: New Tory leader to be announced
- See Brexit timeline for more events
WHAT DOES IT MEAN FOR MARKETS?
- Equity funds registered outflows for the 21st week in a row and the largest since October 2014, while gold funds saw strong inflows and high-grade bond funds saw a strengthening of inflows last week: BofAML
- UniCredit analyst Erik Nielsen says sterling and most U.K. assets remain vulnerable as markets aren’t accurately pricing the risk of a U.K. government destroying the country’s relationship with EU
- STOCKS:
- Deutsche Bank cut its estimates for U.K. retailers, and analysts have reduced forecasts across the real-estate sector and Exane says the risks are skewed to the downside for European investment banks
- Luca Paolini, chief strategist at Pictet Asset Management, says stocks were at their cheapest vs US peers since mid-1990s and could rally strongly once the dust settles
- FIXED INCOME
- In addition to further rate cuts, HSBC says BOE could resume QE, start a new funding for lending scheme and, if broad-based stimulus were needed, could buy gilts on condition the govt uses the proceeds to cut taxes
- Deutsche Bank recommends entering a GBP Libor Dec. 17- Dec. 18 steepener, saying economy will be adversely affected and BOE will likely frontload policy easing; negative rates are unlikely to be pursued
- JPMorgan analysts favor staying long 10Y gilts and entering a 10s/20s flattener, while RBS recommends buying UKT 4.75% 2030 and selling UKT 3.75% 2020 and UKT 3.5% 2045 in a 1:2:1 fly, targeting 35bps as 15Y sector is the sweet spot if the BOE does more QE
- FX
- The pound’s significant outflows after the referendum result reversed only about half of the previous week’s inflows, UBS analysts say
- Markets may not be fully positioned for Brexit given some expect it could be avoided; pound may fall further as it becomes apparent Brexit is the only option so inclined to sell any sterling rallies, BofAML strategists say
- See a structurally lower equilibrium value for GBP with risks of a move toward 1.25 in cable
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
People David Cameron (United Kingdom of Great Britain and Northern Ireland)
Boris Johnson (United Kingdom of Great Britain and Northern Ireland)
Erik Nielsen (UniCredit SpA)
Luca Paolini (Pictet Asset Management SA)
Theresa May (United Kingdom of Great Britain and Northern Ireland)
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