Brexit Court Ruling
By an 8-3 vote, the UK’s Supreme Court ruled that Parliament must pass a bill to trigger Article 50 – a two-year period in which the UK and the European Union will conduct negotiations, and by the end of which the UK must leave the 27-country bloc. Sterling fell marginally by 0.8% after the ruling but recovered to a neutral position by the end of close. Theresa May has also confirmed that the government will publish a White Paper on its negotiating objectives, allowing for a more adequate debate.
Record UK Gilts Issuance
The ruling from the Supreme Court coincides with the announcement of a new £4.3bn sale of long-dated gilts, offering fresh evidence that the appetite for UK government bonds has not been adversely affected by the vote for Brexit. The bonds will mature in 2057 and offer a yield of 1.87%.
There are a number of reasons why gilts are in demand:
- Diversification – gilts can help mitigate some of the risk embedded within a portfolio specially if held to maturity.
- Liability matching – pension schemes and insurance companies hold a significant portion in their funds allowing them to match their assets and liabilities.
- Risk/return profile – gilts are issued by the UK government which have a credit rating of AA – this implies a very low chance of default, which is attractive for investors looking for low risk, albeit low return investments.
Despite expectations that the UK economy will wane on the back of Brexit, its economic health has remained robust (discussed in the next section). This runs contrary to warnings ahead of the vote that growth would weaken but higher inflation would materialise and this would require higher bond yields to stimulate demand.
On Thursday, the Office for National Statistics (ONS) announced the UK’s gross domestic product (GDP), the main indicator of UK economic growth, increased by 0.6% in Q4 2016. The data was above the forecasted 0.5% and was the third rise in a row, showing that UK growth has remained remarkably resilient despite fears over the UK decision to leave the European Union. The data coincides with the UK economy growing 2.0% for the year-end, only marginally below 2015’s 2.2% year-end growth rate. The ONS highlighted the strong contributors were confined to services, in particular consumer-focused industries such as retail sales.
The chart below shows Gross Domestic Product (GDP) which is a measure of economic growth. We show this historically, as represented by the solid lines, and also highlight future expectations for growth in the UK relative to other developed regions, as represented by the dotted lines. While growth in the UK is forecasted to ease marginally, due to uncertainty as we begin to enter Brexit negotiations with the EU, the more competitive exchange rate should be advantageous for industrial activity. What’s worth highlighting is the UK economy has already proved to be resilient, surpassing forecasts several times last year. Regions such as the US and Japan have grown faster, but growth in these regions are expected to slow. This highlights a challenge to a growing consensus looking for continued co-ordinated global economic growth and highlights why there is such a strong focus on Trump’s pro economic growth agenda.
GDP Forecasts (QoQ)
Source: Bloomberg, 2016
Trump Rally and Policies
Donald Trump’s pro-growth policies and corporate tax cut promises have contributed to the strong US equity markets rally. The Dow Jones Industrial Average surpassed the 20,000-point level on Wednesday for the first time in its history.
Dow Jones Industrial Average 5 Year Price Movement
Source: Bloomberg, data as of 26/01/2016
Looking at the increase from when Trump was elected president 6 weeks ago, the index has jumped around 9% – the most compared to any other president.
US Equity Returns* in the Six Weeks since Presidential Election Dates
Source: Bloomberg, 2016 *referring to the Dow Jones Industrial Average
This week Trump told CEOs of car manufacturing firms to look forward to lower taxes if they conduct production in the US, or else expect to incur a border tax of 35%. In addition to this, Trump offered to ease rules on pollution.
Keen to keep his promises, Trump has signed an executive order to build a wall along the Mexican border. In his campaign, he also promised to cut taxes and increase infrastructure spending. However, all of this must be debated by Congress (the House of Representatives and the Senate). A bill will be presented to both houses of Congress and must be passed by a majority vote.
Republicans have remained in control of the House and have hung onto their majority in the Senate, enshrining at least two years of single-party rule in Washington. This should prove beneficial for the US Republican President keen to push though his policies.