Investors prepare for another big Brexit vote
Markets got original referendum spectacularly wrong. Some expect more surprises
When it comes to Brexit, markets now have a new date to obsess over: Dec. 11.
That is when the U.K. parliament is set to vote on Prime Minister Theresa May’s divorce agreement to leave the European Union. If the vote passes, then the U.K. is well on the road to an orderly departure from the bloc.
If the vote fails, a range of outcomes can come next, including a second parliamentary vote, a disruptive, unmanaged exit, or even a second national referendum that could end with the U.K. keeping its EU membership. There is also the possibility of a general election.
Markets got the original Brexit referendum vote spectacularly wrong in June 2016, with the pound falling 13% in the days surrounding the vote.
It was a surprise that reverberated across global markets, as investors fled to supersafe Treasurys and the dollar rallied.
This time around, investors seem to be more on the side of expecting the parliamentary vote to fail—at least in the first go-round.
The pound, seen as a barometer of sorts on the orderliness of Brexit talks, hasn’t rallied with any gusto in recent weeks despite a succession of announcements that a draft deal was imminent. It remains at historically weak levels.
“The chance of it passing has got to be less than 50%,” said Rupert Harrison, a portfolio manager at BlackRock and former senior U.K. Treasury official.
Mrs. May needs a simple majority for the deal to pass, but parliamentary math suggests she has her work cut out. Doz- ens from her own Conservative Party have indicated they could vote against the deal.
She governs with a slim 13vote working majority, helped along because of a political deal with a small Northern Irish party that has also voiced skepticism surrounding the agreement.
Some Conservative politicians have floated the notion that a no-vote on Dec. 11 will spark enough of a market move to spook politicians into chang- ing their votes on a second try, which could happen within 21 days of the first vote. It would be like how the U.S. Congress initially rejected the Troubled Asset Relief Program in October 2008 only to pass it later following a further stock-market collapse.
But it isn’t clear that British markets, even if they do become volatile, will move in a way that pressures politicians. The pound’s sharp fall after the 2016 vote did little to alter the political landscape.
One reason is that falling sterling actually makes the benchmark U.K. stock market go up. The FTSE 100 is packed with multinational firms that earn revenue in dollars and benefit from a weaker pound.
The bond market, arguably more important given its direct influence on government finances, has proven resilient throughout the Brexit process.
Yields on U.K. sovereign debt, known as gilts, fell on the night of the Brexit vote, even as sterling and global stocks swooned.
“The more uncertainty we face the more we have seen there will be downward pressure exerted on gilts yields,” said Ann-Katrin Petersen, investment strategist at Allianz Global Investors.
Some are also worried that the no vote margin in parliament will be so overwhelming, that a second vote won’t even be considered.
“The market will not price in straight away a disruptive no deal outcome, most people still think that as unlikely.
“You could argue that’s what makes it so dangerous,” said Mr. Harrison.
That leaves a yes vote as possibly the biggest surprise for markets, and could trigger volatility of its own as investors look to cover bearish hedges.
“We think the market is probably on the complacent side as to the risks, that means there is the potential for more market volatility than expected,” said Mark Bathgate, portfolio manager at BlueBay Asset Management, which has been making long bets that volatility in the pound will increase. While implied sterling volatility has risen in recent weeks it is still well below its levels before the 2016 referendum.
Whatever the result of the vote, its passage through the typically quiet festive season could exacerbate moves.
“This is going to play out in December which is never the most liquid period for markets. The scope for two way volatility is significant,” said Mr. Bathgate.