Brexit Endgame prompts UK investors to buckle up for wild ride by Bloomberg

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(Bloomberg) – In a year marked by a global pandemic and a surge in central bank liquidity, investors are bracing for a risk they have ignored for most of 2020: Brexit.

The prospect of the UK and the European Union reaching a trade deal before the October deadline seems less likely, with Britain saying this week it was ready to pull out. It risks pushing the pound down to its lowest level in 35 years, stocks that lag behind international peers and bond yields turning negative for the first time amid betting on rate cuts. Bank of England interest, according to fund managers.

“If we have a big sell off of risky assets and a bad Brexit result, then there is no reason the pound cannot fall back to the March lows,” said Mike Riddell, portfolio manager at Allianz (DE 🙂 Global Investors. That would mean a 12% drop to around $ 1.14, the lowest since 1985.

Until recently, the risks associated with failed trade negotiations were in the background, overshadowed by the economic fallout from the coronavirus. The pound, which has served as a market barometer for Brexit since the 2016 referendum, had rallied with other currencies in the Group of 10 countries against the US dollar.

Brexit complacency has prompted Riddell to increase his short position in the pound in recent months and use the pound as a hedge against risk, primarily against the US dollar and yen.

In contrast, analysts in a Bloomberg survey expect only a slight dip to $ 1.30 by the end of 2020, and then gains next year. Economists Goldman Sachs Group Inc (NYSE :)., JPMorgan Chase (NYSE 🙂 & Co. and Morgan stanley (NYSE 🙂 everyone is still anticipating that a trade deal will be in place by the end of December.

But with the resumption of formal negotiations between the UK and the EU this week, those risks are back on investor radar. British Prime Minister Boris Johnson has indicated he will let negotiations fail if a deal is not reached by mid-October rather than a compromise. Officials also drafted a law that risks undermining negotiations, a move that Northern Ireland Minister Brandon Lewis has conceded would violate international law.

The EU’s chief Brexit negotiator, Michel Barnier, is “worried and disappointed”.

Soaring trade tensions took the pound down about 2% this week, to nearly $ 1.30. This raised the cost of hedging the three-month sterling swings to the highest level since May, while Johnson’s comments sparked the biggest jump in six months in options betting on the currency’s decline. ‘by December.

Value trap

Brexit continues to weigh on domestic stocks, falling to an all-time high against the. While a drop in the pound may boost exporters, investors are more underweight the UK than any other country surveyed in a Bank of America (NYSE 🙂 survey of funds for August.

“We see the UK as a value trap,” said Seema Shah, chief strategist at Principal Global Investors. “Valuations can be interesting, but fundamentals aren’t.”

In addition to Brexit, the UK is suffering one of the biggest growth effects of the pandemic in Europe and must decide next month whether to continue supporting millions of workers on leave or face rising unemployment .

This could mean more pain for U.K. Plc, which, combined with concern over a painful EU transition, could fuel further demand for gilts safety. Benchmark yields fell near a record set during the pandemic shock in March, and the two-year bond rate fell to an all-time low of minus 0.156% on Tuesday.

John Roe, head of multi-asset funds at Legal & General Investment Management, expects government bonds to rally if fears of a failed trade talks increase the possibility of UK interest rates falling. negative.

Money markets pushed prices for the BOE to drop below zero in May, compared to September earlier this week. The potential for turbulence also increases the chances of acquiring more central bank bonds.

“It should be remembered that the Bank of England’s forecast is based on the UK reaching a full trade deal with the EU,” said Daniela Russell, Head of Rate Strategy for the UK -United. HSBC participations Plc (LON :), which sees 10-year yields drop to zero by the end of the year.

There is a 40% chance that yields will drop below this figure and turn negative next year, said Jan von Gerich, chief strategist at Nordea Bank Abp (OTC :).

Bare bones

An “outright” free trade deal would be enough to avoid such a scenario and lead Aberdeen Standard Investments to underweight gilts, said Aaron Rock, chief investment officer.

And Citigroup Inc (NYSE :). Currency strategist Adam Pickett said the market had ignored the likelihood of the UK and EU heading towards a last-minute deal, and is aiming for a rally to $ 1.35.

Brexit fatigue could be one of the reasons the markets are so far mainly positioned for a deal. Either way, fund managers will be happy to see the backdrop to an issue that forced them to work nights after late votes that toppled markets, beat two prime ministers and divided the country. . “It dragged on for quite a long time,” Rock told Standard Aberdeen. “It will be better for everyone involved if we can move forward.”

© 2020 Bloomberg L.P.

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