Notes from the Trading Desk – Europe

By: Franklin Templeton

The Digest

It was a strong start to September for global equities as trade optimism and hope for central bank stimulus led to risk-on rotation. Italy’s equity market was the clear outperformer in Europe amid some long-awaited political stability for the country. All three major US benchmark equity indices were higher, and China outperformed in the Asia-Pacific (APAC) region.

Brexit

Clearly, the focus for us in coming days and weeks is going to be UK politics. There was a LOT of noise last week.

The key point now is when and not if we get a general election. We are watching Prime Minister Boris Johnson, who did not want such a thing, and is now desperate to push through an election. On the other hand, we have Labour Party Leader Jeremy Corbyn, who had been consistently asking for an election, looking to avoid one.

What Happened Last Week?

On Tuesday of last week, UK members of parliament (MPs) aiming to prevent a hard-Brexit on 31 October voted in favour of taking control of the parliamentary schedule. The vote was won by a 27-vote margin and included 21 Conservative MPs.

This was the group’s first step towards passing legislation that would force Johnson to delay Brexit, following Conservative defections earlier in the day which saw Johnson lose his government’s ruling majority.

Reacting to the loss, Johnson in effect cast 21 of his MPs out of government. It seems the prime minister had not anticipated the level of rebellion seen from his own MPs when increasing his hard-line rhetoric. This has proven the last straw for some MPs, with Johnson’s own brother resigning as a conservative MP last week. We also saw Work and Pensions Secretary Amber Rudd leave over the weekend, calling the move to kick out these 21 members an act of “political vandalism”.

Johnson faced yet another defeat on Wednesday after the House of Commons rejected the PM’s call for an early general election on 15 October. The legislation, known as the “Benn bill”, passed through both the House of Commons and the House of Lords and is expected to achieve “royal assent”, which means it becomes law. The bill, put forward by the so-called “rebel alliance”, aims to avoid a no-deal Brexit by forcing Johnson to ask for an extension from the European Union (EU) if no deal is reached by the 19 October. Of course, this is dependent on the EU approving an extension.

The market reaction to the proposed legislation was interesting, with sterling having its best week in some time as we saw the risk of a no-deal at the end of October fall. The increased hopes of avoiding a hard-Brexit also helped UK equity inflows.

The domestic-leaning FTSE 250 Index closed last week up 1.61%, outperforming the exporter-heavy FTSE 100 Index, which gained a more muted 1.04%.1   There was high volatility in UK bonds, with the 10-year yield falling as low as 0.35% at the beginning of the week, before spiking up to 0.65% on Thursday on the early success of the Benn bill.

What Next?

This week, MPs will be asked to vote again on whether they support a general election to take place on 15 October, but Johnson seems unlikely to get the two-thirds majority he needs as the Labour party is not expected to support an election this early. The opposition party instead wants to delay this until after the Benn bill has taken effect (19 October), or even later until November, when a no-deal crash out on the 31st of October has been fully avoided.

With Johnson having said he would rather be “dead in a ditch” than ask for an extension, his hopes lie on either winning a general election before 19 October (which looks unlikely, as discussed), or finding some kind of loop-hole in the bill. Otherwise, Johnson’s options seem to be to either go against his word or to break the law. Another would be resignation. That outcome, given his loss of his majority, would hand power straight to Jeremy Corbyn.

There is also speculation Johnson may send the letter requesting an extension to the EU, but alongside this, send some sort of document making it clear that this is not actually what he wants and not what he believes best for the United Kingdom, hoping the EU will reject the request.

In addition, Johnson’s move means that parliament is set to be suspended for five weeks, ahead of a Queen’s speech on 14 October.

In early trade this week, we’ve seen the pound rally versus the US dollar from an initially soggy open after the latest comments from Johnson in Dublin. Johnson conceded that no deal would be a bad outcome for both sides. He said that it would amount to a “failure of statecraft”, and politicians would be “responsible”.

Despite recent rhetoric from Johnson himself, his MPs (both surviving and kicked out)—and the EU hinting otherwise—he insisted he is still determined to get a Brexit deal. Better UK data this morning also helped lift market sentiment a bit.

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.