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What We’re Watching Amidst the Brexit Turmoil

Wells Fargo Investment Institute - December 19, 2019

Key takeaways

  • A host of Brexit-related developments last week suggest that the U.K.’s path out of the European Union (EU) remains more uncertain today than at any time since June 2016—the day after the Brexit referendum.
  • As investors, we believe the outcome that is likely to be of most consequence for the markets, and hence should be given most attention, is the potential for a hard Brexit.

What it may mean for investors

  • We expect Brexit-related uncertainties to contribute to high levels of market volatility in the coming weeks.

Download the report (PDF)

Prime Minister Theresa May’s efforts to honor the U.K.’s June 2016 referendum to leave the EU was fraught with a trifecta of challenges last week: a cancelled parliamentary vote on a Brexit deal, a formal challenge to her leadership from within her own party, and little help from her EU peers in Brussels selling the deal back home. Ultimately, a number of headline developments unfolded in Europe last week that did little to move the needle on Brexit-related progress.

Time is running out—hard Brexit risks on the rise

The current political stalemate in British parliament has opened the door to a host of developments in the Brexit calculus, including the potential for a second referendum, an orderly exit, and a hard Brexit. Amidst the fluid Brexit-related developments, one fact has not changed: the U.K. is still on track to end its EU membership on March 29 (Brexit Day). As a result, today’s headlines are driven by whether or not a Brexit deal will happen prior to Brexit Day.  

So what is a Brexit deal? Simply put, the deal outlines a temporary set of rules governing how individuals and businesses in the U.K. and EU will move about and do business with one another post-Brexit Day. Without a deal, the free flow of individuals, capital, and goods across U.K. and EU borders will abruptly slow after Brexit Day, leading to a host of negative economic and political consequences. This scenario is considered a hard Brexit.

As investors, we believe the outcome likely to be of most consequence for the markets, and hence should be given the most attention, is the potential for a hard Brexit. In our opinion, one reason to track this risk is that the markets likely have not fully priced in the disruptions surrounding a hard Brexit. Each passing day brings the U.K. closer to Brexit Day. The British Members of Parliament’s growing hesitancy to support the Brexit deal presented by Prime Minister May’s government has increased the odds of a hard Brexit.

Hard Brexit related risks rising but not our base case 

While the risks related to a hard Brexit in March are rising, it is not our base case. A key reason we believe that a hard Brexit could be avoided in March is because various EU representatives have offered the chance to delay Brexit Day—the British government simply has to ask for more time.  

Prime Minister May has scheduled a vote on her deal in early January. If this vote does not pass, we believe that a British government likely will seek a Brexit extension from the EU beyond March 29. We believe this to be a likely outcome as a hard Brexit is highly unfavorable for both the EU and the U.K.; therefore, it is in both of their interests to find an eventual agreement. 

We expect Brexit-related uncertainties to contribute to elevated levels of market volatility in the coming weeks. This uncertainty likely will continue to weigh on global market risk sentiment. If a hard Brexit were to occur, investors should expect continued U.S. dollar strength versus the euro and pound in the near term. We reiterate our base case view that an eventual deal will be reached that avoids a hard Brexit and is favorable for risk sentiment.