UK assets show resilience despite vote of no confidence
Yet despite the prospect of more domestic political chaos, UK assets are not showing signs of strain. The pound is looking resilient, holding onto gains from last night whilst gilts, a traditional safe haven investment sold off. The FTSE has been weaker, however that is to be expected given the stronger pound and the inverse relationship between the FTSE and sterling.
There are several reasons why the markets are trading at these levels:
1. Trades are taking an optimistic view of Theresa May’s historic defeat last night. The deadlock is so apparent in Parliament and the result so dire that traders view the chances of a no deal Brexit as greatly reduced. Extending Article 50 and /or a softer version of Brexit, or no Brexit at all are the most viable options now, in the eyes of the market. These are all more beneficial outcomes for the pound and domestic stocks than a no deal Brexit.
2. The market is confident that Theresa May will win tonight’s vote of no confidence. The DUP and Tory rebels have pledged their support to Theresa May. They may not be in favour of her Brexit deal but this isn’t to say that they want a Labour government. Current market levels suggest that traders are comfortable that a win is in the bag for the PM. This confidence is supporting the pound and domestic stocks on the FTSE.
3. Whilst Brexit has been grabbing the headlines trader’s reaction to inflation data was muted. Inflation dropped to 2.1% in December, down from 2.3% in November as expected. Core inflation increased to 1.9% yoy in December, ahead of the 1.8% forecast. Whilst the numbers didn’t ruffle any feathers, the stronger core inflation reading will be quietly offering some support.
If Theresa May loses?
With confidence riding high that Theresa May will see off her rival, the prospect of Theresa May losing the vote tonight is not being priced in. This means that should Theresa May lose, then the reaction could be severe. Developments which add further uncertainty to the already complicated Brexit picture will weigh on demand for the pound. An immediate sell off in the pound would be expected. Sterling would continue to sell off targeting $1.20. The weaker pound could boost the FTSE thanks to the high proportion of multinationals on the FTSE which benefit from the prudential exchange rate.
If Theresa May wins?
The broad assumption is that Theresa May will win. The win is therefore priced into the markets. The market reaction should be limited in the case of a win. Instead traders will quickly look towards discussions surrounding Plan B, which will drive volatility.
Theresa May has until 21st January to put forward Plan B. But with uncertainties going nowhere fast and the clock ticking, business and consumer confidence will remain downbeat. This will keep pressure on the pound and domestic stocks such as house builders, British banks and leisure stocks. Only news of a second referendum or an extension of Article 50 could lift sentiment further from here.
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