Markets climb a wall of worry, and no-deal Brexit is the least of them
It’s back to work this week after the long Christmas break, and back therefore to worrying about Brexit. The odds of a no-deal Brexit have increased markedly since the collective raspberry given by just about everyone to Mrs May’s contortionism, but there is no point in disappearing down that particular rabbit hole again; the ultimate outcome remains unknowable, and all analysis of its various permutations therefore pretty much worthless.
What is worth pointing out, however, is that Brexit is one of only three big uncertainties hanging over markets right now, and very probably the least important of them. The others are whether the US Federal Reserve will continue to tighten in the face of a now evidently slowing global economy, and the outcome of the deeply damaging standoff between America and China over trade.
Together, the uncertainties amount to a kind of “triple witching hour”, all converging on the first quarter of this year. A benign outcome to all three would help stock markets recover some of their mojo. A bad one, and the current correction would quickly turn into something worse. Bear markets in the absence of an outright recession are quite unusual, leading some pundits to conclude that what we are witnessing is more comparable to Black Monday in 1987 and the Russian debt crisis of 1998 than the much deeper sell-offs of the dotcom bubble and the financial crisis. In both cases, markets soon rebounded.
Has the Fed already blinked? Certainly that’s how markets interpreted remarks on Friday by Jay Powell, the chairman, when he indicated a willingness to shift path if the data warranted. We’ll see. We’ll also see whether the resumption of Us-china trade talks signals an end to current tensions. And though a prolonged transition with neutral economic consequences still seems the most likely form of UK withdrawal from the EU, we’ll see on that front too. If stock markets continue to recover while these matters remain unresolved, with a now sharp downturn in China piling in on top, it will be against a wall of worry, making shares particularly vulnerable to renewed setback.
The biggest victim of the vote for Brexit to date has been the value of sterling. Since the final quarter of 2015, when Brexit first became a distinct possibility, the pound has lost nearly a quarter of its value on a trade weighted basis, making this one of the most serious devaluations of the post-war period. You’ll be pleased to know, however, that according to true believers in the economic benefits of Brexit, this is a good thing, as it ought, by making exports cheaper and imports more expensive, help induce a much-needed rebalancing in the UK economy towards net trade.
Unfortunately, there is as yet no sign of it. As a proportion of GDP, net trade is no higher today than it was three years ago when the devaluation began. Indeed, the only observable impact of the exchange rate correction so far is that relative to the rest of the world it has made us all notably poorer. This should in truth come as no surprise, since none of the previous devaluations have had any long-term impact on trade either. Down and down the pound has gone, but just as dependent on household and government consumption for our growth do we seem to remain.
Why is this? Why has the economy failed to adjust as you might expect? Samuel Tombs, of Pantheon Macroeconomics, suggests three explanations. One is that UK exporters are these days highly integrated into international supply chains. The price advantage they gain from currency devaluation in export markets is therefore largely lost on the higher prices they pay for imported components and raw materials.
Second, Brexit uncertainty is causing European customers to shun British suppliers in favour of Continental alternatives. Supply chains are being reworked in preparation for barriers to trade.
And third, there has been surprisingly little import substitution, possibly because British manufacturing has become so acutely hollowed out over the years that it is incapable any longer of responding to increased demand. Brexit uncertainty has also depressed business investment, further crimping the UK’S ability to substitute for imports.
The upshot is that so far there has been zero gain from currency devaluation, only cost. Sorry for the disheartening message, but if the effect of a no-deal Brexit is to devalue the pound further, we are quite unlikely, in the medium term at least, to see a silver lining in the shape of a significant boost to net trade.
An anonymous civil servant was recently quoted in The Daily Telegraph as saying the Government had been less than truthful about preparations for a no-deal Brexit, preferring instead to let Project Fear Mark III run wild in an effort to convince MPS to back its hated Withdrawal Agreement. In fact, he said, the country is fully prepared with “very detailed plans”.
If so, I wish the civil service would spell them out. The fiasco of Seaborne Freight – the shipping company without any ships awarded a £14m Brexit contract – strongly suggests a very high degree of continued incompetence and lack of reliable forward planning. For instance, no guidance that I am aware of yet exists for what the Government intends to do about tariffs. In theory, the EU becomes subject to exactly the same tariffs as any other “third country” without a free-trade agreement, such as Australia or the US, in the event of a no-deal Brexit.
But is that actually what the Government intends to do in practice, given the likely impact on food prices and existing supply chains? And if it does, will it cut taxes such as VAT to compensate? It could of course decide not to impose any tariffs at all on the EU, but if it does, it would be forced under WTO rules to offer the same tariff-free trade to everyone else. Is unilateral free trade an option or not? Alternatively, it could set its own universal tariffs according to the perceived needs of the UK economy. But should we not by now know what these are likely to be?
Guidance issued by the Department of Health last week brutally warned medical equipment suppliers that their UK certification would no longer be valid in Europe after March 29 in the event of no deal and “as such these products will not be able to be placed on the EU market”. Where then are they to be placed? Since UK regulators intend to continue honouring foreign EU certification, it is not obvious the DOH will compensate by taking the exports instead. It is a quarter to midnight, and we know none of this stuff. Very detailed planning? I can barely see any at all.
‘The uncertainties amount to a kind of triple witching hour, all converging on the first quarter of this year’
A trader on the floor of the New York Stock Exchange. Markets started the new year with a tumble, as disappointing Chinese economic data renewed concerns about a global trade war