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Chaos Confusion and Suspense

Oct 22, 2019

• Another Brexit saga but the UK Prime Minister may still push it through
• Sterling may initially sell-off but traders fear the upside as much as the downside
• Latin America sees trouble in Chile and Ecuador, but Brazil and Mexico retain positive bias
• IMF cuts GDP forecasts and ups its research on climate change
• Institutions increasingly focused on implementing ESG strategies
• US government increasingly taking over the uninsurable.

Chaos, confusion and suspense are never far from the Brexit saga. This weekend certainly filled the bill. Mr Johnson’s intended Super Saturday of success was transformed into a damp squib. The success of an amendment to the motion approving his deal with the EU27 means final sign-off will be delayed until all the ‘enabling’ legislation has passed into law.

On the face of it, the Prime Minister may still get his way even if there are more hurdles to overcome. Indeed, the voting pattern on Saturday suggests that the most likely outcome is that the amended Withdrawal Agreement is eventually approved by Parliament in its current form and the UK departs the EU after a technical delay.

Yet, as ever, danger lurks. The big Boris Johnson push has had its momentum broken and an extended period of debate on the hard-fought agreement may expose its shortcomings. The EU27 still have to respond to the UK’s request for a delay. A delay cannot be taken for granted. Many still believe that it is most likely that the EU will give an extension but for how long? A month to allow approval by both UK and European parliaments or longer still to cater for a UK general election if the Commons rejects the agreement. For now, the European Council will hold fire to see what happens in London in the coming days.

The disappointment of a messy weekend is likely to weigh on sterling after the run-up of recent days initially. However, now that the traders have seen the upside potential rather than the perennial gloom that had previously prevailed the near-term setback in sterling could be modest.

We sense the markets wants to price better news if only Parliament would deliver. The good potential news though is that the relief of the UK’s departure from EU and some semblance of certainty should boost UK economic activity going into 2020. A rebound in investment spending, improved business and consumer sentiment and of course a pending fiscal boost should see at least 1% added to GDP in 2020.

Further out, there will be reflections on the fact that the deal negotiated by Boris Johnson does differ in tone in comparison with the May version. It looks in the future to a form of managed divergence with EU regulation and standards compared with the earlier alignment approach. This will be central to negotiations (as well as the debate in the upcoming UK general election) over an eventual free trade agreement. The UK negotiating leverage may well be weaker no doubt, but the EU is itself already alert to this challenge and will want to see the long-term relationship nailed down as quickly as possible.

Chaos confusion and suspense are increasingly the tone of Latin American politics dragging down the economies and markets. Chile was the latest country to see popular anger. Chilean President Pinera was forced to suspend an increase in subway fares to violent protests. As in other countries, student protests have morphed into broader movements for change. Chile is facing its toughest political challenges since the end of the dictatorship of Augusto Pinochet. In Ecuador, the government has had to cancel an austerity package to quell violent protests that had rumbled on for 11 days. Argentina is in the midst of an election for the next President with a left-wing Peronist looking likely to win over the incumbent. Latam financial markets are challenged. However, the good news is that Latin American heavyweights Brazil and Mexico are doing enough to keep investors engaged. Brazil continues with a reform programme and although Mexico has hit a problem this past weekend with the arrest and release of a member of a infamous criminal family increasing confidence that US-Mexico-Canada trade agreement can be amended and agreed by Congress has helped sentiment.

The IMF was busy announcing cuts to its global growth forecasts in its mid-year update. It now expects global growth to be 3% in 2019 – down from 3.6% last year and a 0.3 percentage point cut from its April forecast. The IMF expects growth to pick up in 2020 to 3.4%, but that represents a downgrade from the 3.6% forecast six months ago.

Worryingly the IMF pointed to the fact that central banks were using their ammunition to stave off the effects of the trade war, leaving fewer options if a recession were to set in. The IMF calculates that global growth would have already been running at a pace 0.5 percentage points lower were it not for lower central bank policy rates in recent months.

Concerns over climate change point to a future of potential chaos, confusion and suspense. The IMF has announced that they have finally got around to investigating the potential impact of climate change. New IMF managing director Kristalina Georgieva announced that “the IMF is gearing up very rapidly to integrate climate risks in our surveillance work”. The IMF’s new focus comes as recent data from NASA shows that observed levels of carbon dioxide continue to rise almost every month. The latest reading from NASA at 412 CO2 parts per million compares to just less than 380 in 2005.

There are signs of the US private sector extracting themselves from markets prone to climate change. However alarmingly the private sector is being replaced by the public sector as lender and insurer of last resort. For example, according to a Harvard business review, hardly any private insurance company retains residential flood risk in Florida or Virginia. Government-subsidised programmes are having to take up the risk. A A recent paper the US National Bureau of Economic Research showed that commercial banks are offloading mortgages on properties at danger from climate change on to the government agencies of Fannie Mae and Fannie Mac. Governments may be well-intentioned, but they are building a sizeable contingent liability.

Bloomberg ran a story this past week, showing that some institutional funds are starting to snub the $16 trillion US Treasury market based on ESG criteria. The French state pension fund is amongst major European funds that are shunning Treasuries due to the US government’s stance on climate change and/or capital punishment. I’m not sure Donald Trump will be losing sleep over the matter, but it’s maybe a taste of what is to come.