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Brexit clamour vs. real market new

27 September 2018

The UK’s establishment had pinned high hopes on a Brexit break through at the EU’s Salzburg (non-Brexit specific) summit. The rest of the EU had different agenda priorities and so disappointment was inevitable. Judging by the vastly different media interpretation between Continental and UK media outlets the Salzburg snub is a matter of interpretation. French and German comment centred around the detail of the proposed Northern Ireland border solution, not the Chequers plan altogether. Otherwise it was seen as presumptuous that the UK side felt duped that their plan to ask for broadly the same trade benefits without being a member was not warmly welcomed. No suggestions of intentional humiliation of the UK’s prime minister.

It would seem to me that the interpretation that a cliff edge no deal Brexit has become much more probable now is a vast exaggeration. Much more likely that it is all politics once more – or rather playing to domestic electorates and party conference expectations. The Irish border issue is solvable, given the Canary Islands are part of Spain and the EU customs union, but not the VAT regime. This already requires inner-European customs processing without anybody seeming particularly bothered by it.

For Theresa May’s position at the October Tory party conference on the other side, being in a state of frontal conflict with the EU may proof to be a much stronger platform than being at the compromise stage of negotiations.

Far more interesting for the near-term perspective of global investment was once again non-Brexit related news-flow. This led to a positive week in global stock markets, but interestingly to a lagging of the US market which had thus far been the undisputed leader for the year. Global trade concerns eased as the Trump administration refrained from imposing 25% tariffs on China as signposted by Trump. The 10% tariffs put in place instead are valid until the end of the year and can then be raised to 25% should no deal be done. China’s retaliation was equally softer than expected. This furthers the view that a deal will be done by year end and the 10% for such a relatively short time period is seen as not constituting a significant threat to either the US’ or China’s economy.

That US stock markets did not rise as much as other markets may have had less to do with lowering trade tensions, then with a sudden step up in long term bond yields in the US, which had been static since the last step up in February. Different to then and contrary to perceived wisdom that higher yields increase the attraction of US$ holdings, this time the US$ weakened – and stock markets did not panic (like they did in February).

There have been plentiful interpretations as to the deeper reasons for the change in market dynamics in the US since August, but regular readers  will know that we had been expecting this to happen in due course as inflation expectations have begun to lower future expectation of (real) returns after inflation.

The weakening of the US$ in combination with an improved outlook for global trade is good news for emerging markets (EM) where stocks have been badly beaten up this year as the dollar kept rising and trade volumes declined. Expectations that the Trump trade wars will end sooner rather than later also suggests that the Chinese leadership can effectively counter the inflicted slowdown with decisive short term fiscal and monetary stimulus measures. In 2015/2016 similar action resulted in a massive boost to global demand. Even if the stimulus is less prominent this time, there is a growing perception that the EM liquidity crisis and trade slowdown may be nearing its end.

Should the observed decoupling of rising US yields and rising US$ be a sign that risk capital is beginning to turn its back on the US in search for better (real) valuation opportunities, then we may indeed be witnessing of a rotation of capital market leadership away from the US, where growth in real terms may well have peaked.