The Daily Update - May day! May day!

May Day! May Day! Markets this morning braced themselves ahead of what has so far been the most important speech of UK PM Theresa May’s career, where today she shed some light on the highly anticipated Brexit strategy.

UK markets awoke with an acute risk-off tone which saw the yield on 10-year Gilts fall ~5bps to 1.248%, and the FTSE Index plummet ~0.45%; within the first 15-20 minutes of opening. The FTSE continued to track lower after Theresa May stated that the UK ‘cannot possibly’ remain in the European single market while the yield on the benchmark gilt spiked to an intraday high 1.32%. Although departing from the single market is not the best news for markets, at least it is confirmed. Incidentally this was already pretty much priced in anyway as May has reiterated this point since last year, and the Brexit blueprint was leaked ahead of May’s address.

Meanwhile currency markets interpreted May’s announcement - that the exit deal would be passed through a UK Parliamentary vote and that new trading opportunities would be sought - as positive; sterling rallied sharply gaining ~1.5% against the euro and ~2.5% against the dollar, at time of writing. Dollar sentiment had taken a knock after Donald Trump stated in an interview with the Wall Street Journal yesterday that the dollar is ‘too strong’, this coupled with his anti-globalisation rhetoric alone has seen the DXY (dollar) Index fall over 1.7% so far this year.

The main takeaway from May’s speech is: the UK is to leave the single market, but Britain would seek an ‘associate membership’ of the customs union and ’a new equal partnership -- between an independent, self-governing, global Britain and our friends and allies in the EU’. On immigration, May stated control over Britain’s borders was a priority, adding that the nation will continue to welcome ‘the brightest and best to study and work in Britain’, however there will be control over numbers from the EU.

It is still too early to tell how the UK economy will be affected by a ‘clean Brexit’ as negotiations will commence once the Parliamentary vote is cast. The IMF did however upgrade the UK’s economic growth forecasts to 1.5% for this year, pencilling in a downgrade to 2018 growth expectations to 1.4%; the caveat of possible trade barriers and other unknown Brexit effects could see these forecasts revised somewhat however.

Aside from the impact on the UK itself, one has to consider the exit’s bearing on the EU post-exit. The politico-economic union will lose a huge source of funding (GBP13bn alone was paid in contributions to the EU in 2015), and one must consider the consequent effects on the current tariff free trade agreements, where the UK imports roughly 50% of its goods from the EU. The EU is also expected to face a continued wave of anti-establishment and anti-globalisation sentiment from other nations this year with the impending French and German elections.

Our global bond portfolios are exposed to the UK via Scottish Widow’s 5.5% 2023, for example. Rated BBB+ by Moody's and S&P and A- by Fitch, this bond has held-up remarkably well. While the yield on the comparable 2.25% 2023 gilt has only fallen 2 bps since the referendum result was announced, the Scottish Widow issue has rallied 5.9 points, with the yield trading 107 bps lower. The sterling bond continues to offer very attractive risk adjusted expected returns of ~9%, with a yield over 3.87% and 4.7-5.7 notches of credit cushion (depending on the rating used).