Ireland has come out in support of British Prime Minister May’s plan to sidestep a hard border cutting through the island of Ireland. Ireland want to avoid needing to enforce customs in €65bln in trade with Britain each year, and May is fighting to avoid the same between NI and Britain (hopefully bringing the DUP back on side) and of course any outcome better than a no-deal Brexit.
Last week the EU signed the world’s largest bilateral trade pact with Japan – reducing friction in the eastward flow of wine and cheese and the westward shipment of vehicles and parts – five years in the making. However, this week is another story and the EU faces the further undoing of such Trans-Atlantic trade relations as its diplomats stand-up or stand-down to Trump’s escalating trade demands. According to Donald Trump yesterday, “Tariffs are the greatest!” – unless of course they are levied against the US like the EU’s £3bn retaliatory tariffs on bourbon and bikes.
This morning, the euro rose to a 10-day high along with sovereign yields across the EU as ECB Chief Economist, Peter Praet gave a rather typical presentation outlining the journey and challenges of “Monetary policy in a low interest rate environment” to the “Congress of Actuaries” in Berlin (I know, how did we forget to put this in the diary?). His formal remarks, as usual, were dry but a good synopsis of the factors and thinking that have guided the Central Bank’s current policy stance: highlighting the “innovative and bolder measures” particularly their “Asset Purchase Programme (APP) [which] has been the pivotal component of [their] strategy for countering and reversing the crisis.”
Holders of Italian 2-year debt brought new meaning to the idea of “paying the price for volatility” given that (until a fortnight ago) they actually prepaid – in negative yields – for the privilege of exposure to Italian market risks. In May alone, Italian short term yields went from -0.15% to close yesterday at 2.70%; 185bps of this 285bps move occurred yesterday. This was unprecedented and equates to 18 standard deviations beyond the average daily move over the past decade (which itself was quite high during the Eurozone Crisis of 2011/12).
Not that the German economy has fared poorly in the past four months, but the political stalemate that has endured over that period is finally moving forward - with Chancellor Angela Merkel’s conservatives (CDU/CSU) yesterday agreeing terms for a renewed ‘grand coalition’ with Martin Schulz and the SPD. But many on both sides still oppose the pairing which in some ways seems about as unmelodious as the UK’s Clegg-Cameron-Coalition of yesteryear. So in the typical drawn-out fashion a final vote on the deal, by half a million registered SPD members, is still required and expected by the 4th of March.
The UK has finally caved to the EU’s disaggregated approach to Brexit negotiations: agreeing in principle to give around €55bn (as part of the eventual package deal) to compensate for retracting from future funding of the EU budget. The argument that such a stance was illogical (as they certainly wouldn’t enforce a leaving subsidised-member to continue receiving payments or impose a leaving-bonus) gained no traction after many precious months; neither did the previous €20bn and €40bn offers by Prime Minister Theresa May. Given that early talks of what the UK ‘owed’ were in the range of €60bn it seems that already in the first few items the UK as conceded much, and the EU precious little.
There are certainly reasons to be appreciative of being British today; from those on Portsmouth dockside welcoming home the HMS Queen Elizabeth Carrier to those wading through the latest data from the ONS showing, for instance, that employment rate (75.1%) has hit its highest on record and unemployment (4.4%) is at its lowest in 42 years. But less so in regards to the first in a series of detailed Brexit position papers setting out the ‘Government’s vision… to build a new, deep and special partnership with the European Union’. Guy Verhofstadt, former Belgian MP, current MEP, EU Brexit negotiator and author of ‘Europe's Last Chance’, sums up the central stance of the papers as ‘a fantasy’.
Today, after 9 months of waiting, the Brexit referendum has finally given birth to Article 50. In a sign of the times, the President of the European Council Donald Tusk notified the world of his receipt of the official letter via twitter a few minutes before 12:30 GMT. Prime Minister Theresa May then addressed the House of Commons calling the occasion a ‘great turning points in Britain’s history’; meanwhile Tusk opened his address stating ‘There is no reason to pretend this is a happy day, neither in Brussels nor in London,’ and concluded with ‘we already miss you’.
Just one week until Britain is expected to trigger Article 50, sterling at a three week high, UK inflation highest since 2013, leaked EU documents suggesting Britain could be kicked out EU and fined £50bn, Bank of England (BoE) Chief Economist Andy Haldane postulating a base rate rise to 4.25% that could wipe out 1.5 million jobs but boost productivity in the long run, Scotland pushing harder for another independence vote, and the BoE predicting a further retail slowdown: all in all perhaps enough commotion to burrow yesterday’s embarrassing infighting of the Labour Party. Or perhaps not.
In light of the UK triggering Article 50 to begin the process of leaving the European Union, Jean-Claude Juncker, the Chief Executive of the EU is said to be looking at options to bring closer together the remaining states as he fears there could be pressure for further unravelling. Juncker believes that while some states want to deepen co-operation faster and further than before, others are not so keen. In a White Paper, Juncker will argue for a ‘multi-speed Europe’ because as he sees it ‘This is no longer a time when we can imagine everyone doing the same thing together.’ Junker will ask for responses to his ideas by the autumn, by which time the German and French elections would have taken place.
1st March 2067 is the distant maturity of the latest €5bn bond issuance from Italy. Even in the wake of European immediate concerns, talk of the ECB reducing QE and Italian banks fears not to mention the Deutsche Bank furore - subscriptions for this first ever 50 year bond from ‘Il Bel Paese’ were 3.7x oversubscribed. €18.5bn of investor money was keen (or at least reluctantly persuaded) to bet on Italy’s ultra-long-term creditworthiness at underwhelming spread of 52 basis points over Bunds. Not us.
Markets are relatively quiet in anticipation of the main event of the next 24 hours – tomorrow’s Governing Council Meeting of the ECB in Frankfurt (or perhaps for some it is the new iPhone release and Apple keynote presentation later today). However, happenings on the other side of Germany are worth watching too, namely the state legislature win of the anti-establishment Alternative for Germany Party (AfD) in Mecklenburg, home state of ‘Mutti’ Merkel, pushing her Christian Democrat Party (CDU) down to third place. This could turn out to be a significant antecedent to a further rise in the populist anti-immigration AfD Party and even lead to a swing in federal elections in 2017. Current opinion polls put the AfD in the mid-teens which if held or increased would give them enough seats in parliament to encumber the usual grand coalition between the CDU and the Social Democrats (SPD). An even a small interloper in the Bundestag could obstruct political decision making at the heart and industrial engine of the Eurozone, just at a time when reforms and decisiveness may be needed across Germany and the Eurozone.
Yesterday’s United Nations (UN) Arbitral Tribunal ruling against China’s claims over the South China Sea will do little to resolve the various international disputes over this resource rich and busy trading route. Today, China has already countered the ruling with a detailed defence of their position titled, “China Adheres to the Position of Settling Through Negotiation the Relevant Disputes Between China and the Philippines in the South China Sea”.
So what are the other European countries that face the greatest increase in political instability following the Brexit plebiscite results? From our value investment perspective much of European credit had already offered little value relative to the high level of net foreign debt in some states and the political impasse that continues to hamper growth. Now with the added uncertainty from antagonistic negotiations, far right (and left) political parties across Europe have been given a boost in confidence and support as has the possibility of other Euro/EU referendums. This further detracts from their appeal for long term value investors, but which states in particular face the most immediate concerns?
We always knew the upcoming vote on the UK’s membership of the EU had the potential to split the Conservative party; however, it is a leading anti-EU campaigner resigning over welfare cuts that could spark it off. Although not quite at the civil war stage as yet, Friday’s resignation of Iain Duncan Smith, the Work and Pensions Secretary, over the recent budget does have the potential to damage not only the Tories but also the argument for Britain to stay in Europe.
“Once-in-a-lifetime opportunity” were the words used by London Mayor and Conservative MP Boris Johnson when he announced that he will back the campaign calling for the UK to leave the EU. Talking to reporters outside his house yesterday he said that, “after a huge amount of heartache” he will be “advocating Vote Leave, or whatever the team is called, because I want a better deal for the people of this country: to save them money and take back control.”
“Should the United Kingdom remain a member of the European Union or leave the European Union?” That is likely to be the even-handed question to be set before the 46 million strong UK suffrage by the end of 2017 (but could be as early as May/June this year). With the release of a 16 page EU renegotiation statement by Donald Tusk, President of the European Council, the pound continued to gain strength against the dollar (although only slightly from the 7 year low of two weeks ago) suggesting that the prescribed concessions were more than expected. But whether they will develop enough substance to sway the nationalistic British public to vote to stay “In” a reformed EU will be a question that only the eventual referendum will answer. Of the “four freedoms” that form the core ethos of the single market: people, capital, goods and services; no prizes for which of these will form the tipping point for the referendum.