Year of the Rat Outlook: Will 2020 see a Brexit deal done?

Every Chinese New Year, AsianInvestor makes 10 predictions about developments that will affect global financial markets and the portfolios of Asian investors, especially asset owners. These developments can focus on asset classes, geopolitical events, or structural issues surrounding particular markets.

In our final Year of the Rat outlook, we turn our eyes to the continuing saga of Brexit.

Will the UK reach a trade deal with the European Union this year?

Answer: Yes (a very basic one, accompanied by an extension of the transition period)

Now that Britain has officially left the European Union, as of January 31, the next target is to agree a trade deal by the time the transition period expires at the end of the year. But reaching a compromise acceptable to both sides is likely to be as tortuous a process as the horse trading since the June 2016 referendum.

Realistically, there are four potential outcomes by the end of this year: a trade deal; another extension (the government has said that is not an option, but then they did last year too); some mixture of the latter two; or leaving with no deal.

Prime Minister Boris Johnson – buoyed by a newly-won parliamentary majority for his Conservative Party – has already set a combative tone, asserting that the UK will diverge from EU rules and regulations, to the dismay of many in the UK’s business sector.

Yet Johnson is both an opportunist and a pragmatist. He may not stand by apparently strongly held principles, especially if he spies a politically convenient solution to abandon them and still claim a win. In any case, he may be unable to keep such promises by setting overly ambitious red lines.

Ultimately, some form of deal would suit both sides best, and a no-deal would be particularly bad for the UK.

Hence AsianInvestor predicts they will come to a very basic agreement, with many loose ends to be tied up next year. And since an extension is likely necessary to facilitate this outcome, that too will happen, despite Johnson’s opposition to such an outcome. After all, trade deals of this magnitude usually take several years to negotiate.

And the implications of all this for markets?

Swinging asset price volatility will continue for the UK’s currency, bonds and stocks for at least this year. And there will be more downside than upside surprises

Swinging asset price volatility will continue for the UK’s currency, bonds and stocks for at least this year. And there will be more downside than upside surprises. Given how far apart the two sides’ starting positions are, Johnson will have to gradually moderate his demands.

Overall, sterling – which since October has traded between £1.29 and £1.35 to the dollar – is likely to weaken this year, in light of the renewed uncertainty and expectations that the Bank of England is likely to hold or cut interest rates rather than hike them.

As for gilts, the yield curve is likely to bear-steepen – with 10-years yields rising relative to two-year equivalents. “Playing curve movement could be a source of value to fixed income portfolio managers … particularly with many central banks now on hold,” said fund house Amundi in a note on February 6.

UK equities are the source of most optimism. They’re seen as cheap now relative to global stocks. While there won’t be a big splurge in 2019 terms of corporate spending and investment, there is a lot of pent-up demand, and sentiment has improved, particularly around domestically focused stocks. So while FTSE 250 valuations may remain fairly subdued in 2020, some of those names look a good long-term bet.

But if the widely feared tail risk of a no-deal comes to pass, most bets are off. Sterling will tank, and with it likely many other assets. That's not AsianInvestor's expectation, but stranger things have happened in recent years.