With May, you must hedge
As we face into yet another week of uncertainty over what decision the British political class will take in the context of either executing Brexit, maintaining the current status quo on life support via an Article 50 extension or ultimately taking a decision for some radical high-risk surgery in the guise of a new referendum, businesses remain at the coal face dealing with the fallout this uncertainty has wrought. While it was always anticipated that the UK/EU Brexit negotiations would prove to be difficult, the dearth of any substantive progress in the past 31 months is of grave concern and the continued volatility is making it very difficult for Irish exporters with significant trade ties to the UK to have certainty over margins from sales and purchases unless they have hedging strategies in place.
This supreme exercise in internal bickering and can-kicking is taking much longer than we at Investec and the broader financial markets had expected and it has been infinitely more painful and time consuming than we ever imagined it would be. Unsurprisingly enough, as we approach ever closer to the March 29th 2019 ultimatum, this time bomb that is a ‘no-deal Brexit’ scenario has started to tick ever louder. What is surprising however is how well the UK economy has been performing in the face of this level of uncertainty. Up to Christmas all the major economic data points (inflation, employment, growth and retail sales) were pointing to a reasonably robust economy, so much so that the BoE has found it appropriate to hike the base rate by two 0.25% increments in recent months. However, recent sales data from retailers for the crucial Christmas period may signal some weakness as the full realisation of the potential adverse effects of Brexit take hold. As is the norm though, it is sterling that historically tends to bear the burden of uncertainty. It suffered horrendously during the apex of the global financial crisis in ‘08/’09 and while not as violent or pronounced as ten years ago, the pound has had little to cheer about since the shock referendum result of June 2016. That said, in recent weeks, the pound has continued to strengthen as fears of a ‘no-deal Brexit’ dissipate.
To say we’re in unchartered waters is quite the understatement and such is the scale of political divisions within and without party lines, that the prospect of unusual and unprecedented alliances are becoming ever more real. After an historic 230 vote defeat first time around Theresa May’s withdrawal agreement was considered dead in the water. However, given rising opposition to a “No Deal” Brexit in parliament, the past week has seen some Brexiteers come to a realisation that this could be their best chance at getting a Brexit of any form across the line. Furthermore, there have also been a number of amendments proposed which appear to have cross party support aimed at avoiding a “No Deal” Brexit. This turnaround in expectations is supporting the pound, which traded at two month highs against both the euro and the dollar during last week. In particular, two amendments tabled by the Labour Party have been the main drivers behind the pound’s recent uptick. Yvette Cooper’s amendment which opposes a “No Deal” and also forces Mrs. May to request an extension to Article 50 if a deal hasn’t been approved by 26th February. Up next we have Jeremy Corbyn’s contribution which again rules out a “No Deal”, proposes a move to a softer Brexit and also suggests holding a second referendum. If either of these are accepted they would eliminate many of the most pressing fears of Brexit (March deadline, and cliff edge Brexit), although they would prolong the Brexit agony.
It doesn’t need the expertise of a treasury advisor to highlight that, as a net exporter to the UK, a strong UK economy and an even stronger pound is crucial for the Irish export sector (to the UK) to remain competitive. As such, the aftershocks of the UK/EU (Brexit) referendum of just over 30 months ago are still being felt, with the value of sterling more often than not the first respondent to current Brexit sentiment. Leading up to the seismic Brexit vote of June 2016, Irish exporters were comfortable with the euro trading in a £0.70 to £0.80 range, trading at an average of £0.77 in the 30 months prior to the referendum vote with relatively limited volatility. Now with just two months left before “B Day” on 29th March, sterling (at £0.87) does remain some 4% stronger than it was just over three weeks ago but one must be mindful that the average rate has been close to £0.88 in the 30 months since the referendum vote. That’s somewhere in the region of a difference of 13/14% between the two (pre-vote & post-vote) 30 month time periods, a hard pill to swallow for the Irish export sector.
While stronger than the recent lows of in/around £0.91, we would be wary that the current GBP strength may be overdone as we feel much of the relief is predicated on the expectation that an extension, or amendments to the Withdrawal agreement will be granted by the EU without opposition or conditions attached.
With the prevailing uncertainty there is only one constant, with May, you must hedge.