Markets Weekly podcast - 14 Dec 2020

Henk Potts (HP): Hello, it’s Monday the 14th of December and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets. My name is Henk Potts, Market Strategist with Barclays Private Bank, and each week I'll be joined by guests to discuss both risks and opportunities for investors.

This recording will last around 15 minutes and be broken down into three component parts. Firstly, we will analyse the prospect of the UK and EU negotiating a trade agreement and discuss the impact if they fail to do so.

To help with this task, I’m pleased to say I’ll be joined by Peter Gordon, Head of Government Relations for Barclays. I will then look beyond Brexit to highlight other factors which grabbed the headlines and moved the markets over the course of the past week. Finally, I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.

One topic, of course, dominated global news tickers over the course of the past week. British and European negotiators played a dangerous game of deal or no deal, forcing analysts to model the likely implications for businesses, economies, and financial markets if Britain were to conclude its transition period at the end of this year without a trade agreement.

Expectations of the endgame would have played out over the course of the weekend. But, as we now know, in a joint statement Boris Johnson and Ursula von der Leyen said the negotiations would continue beyond Sunday's deadline.

So, let's look at the Brexit negotiations in more detail with our guest Peter Gordon. Peter, good to have you with us today. I suppose if we're looking for positives, it’s the fact that both sides are still talking. You could argue neither side wants the blame for ending the talks early. The negatives are still there though, as substantial gaps remain. Where are we with the talks?

Peter Gordon (PG): Henk, thanks very much and great to be on the podcast. As you say Henk, another deadline has come and gone, which is something that we've seen happen several times before in Brexit. I think what that indicates is something we've always said, which is that basically both sides do want to do a deal. That is a fundamental truth. What we understand happened at the weekend was that there was some new ground found on this very complicated issue of post-Brexit - essentially will the UK remain aligned to EU trading standards.

Specifically, if the UK were to not remain aligned, what is the policing mechanism for that? And then also, what is the punishment? Now in previous iterations of talks, the EU were talking about perhaps some kind of judge/jury/executioner role, where it could impose quite lightning tariffs etc. The UK didn't want to go down that path. Where we seemingly have landed is more of a sensible idea where there could be some kind of independent arbitration mechanism.

Any divergence will be dealt with on a kind of sector-by-sector basis. So the talks continue. But again, time is upon us because of course, Henk, as we know the only real deadline in Brexit is the 31st of December and that is not too far away. So I think this is a really important week.

HP: Thank you. We know, of course, the UK and the EU as you quite rightly mentioned have clashed over a number of key areas, whether it’s fishing rights, it’s the level playing field or indeed governance. What are the major points that are still proving insurmountable and can we argue maybe from a UK perspective, it's a question of whether economic pragmatism or sovereignty will win the day?

PG: Thanks Henk. I think it comes back to this fundamental question of what is broadly called ‘a level playing field’ and from an EU perspective the stance that they're taking, completely understandably so, is if the UK want to access the EU internal market it obviously has to maintain those EU standards. So, everyone can agree on that. That's not a problem.

The problem becomes where the UK in principle as a sovereign post-Brexit nation perhaps doesn't want to align to those standards, or perhaps there's innovation in a new sector and it’s the UK that is setting new standards. What happens then? So the question of what happens around this broad topic of divergence has been something that's bedevilled the talks for several months but is coming to a head again at the moment.

What was really interesting at the weekend, was Dominic Raab, UK Foreign Secretary, making it quite clear on the weekend political shows that the UK gets it in so far as the UK knows that if it diverges from EU standards there will be a price to pay. That in itself is quite a big move forward from the UK position. They’re really moving into the detail of what that mechanism is now, to judge whether divergence has come and also what the punishment would be.

Of course, linked to that is the issue of fishing, but it's always been felt that if we settle the level playing field arguments we should perhaps get a good outcome on fishing as well.

HP: Okay, it’s time for me to put you to the sword now. Is a deal still achievable and, if so, what would it look like?

PG: Thanks Henk, the US$64,000 question. Look, I've always maintained the view - and I stick with it - that on balance I do think that we will get a deal at the end of this. Everyone is well aware we are at least 95% of the way there. As I understand, the actual deal itself runs to about 800 pages so we're tantalisingly close. The reason I feel that we're heading toward a deal is simply the consequences of no deal.

We began to see that over the last few days, the consequences of no deal are quite severe from an economic perspective and, of course, a political perspective, both in the UK and the EU. That desire to avoid that outcome is something of course that is driving the talks, and, as we said at the top Henk, we thought that perhaps at the weekend that could be it. That could be the moment where the talks were officially off. But again, I go back to my earlier comment: there is genuine desire on both sides to do a deal.

Whilst a no-deal is still possible, we should be in no doubt about that it is absolutely still possible. I do think we are getting very, very close. But as I'm sure people are aware, we shouldn't expect some radical big brand new trade deal. It's going to be a very basic deal which at the very core of it will allow zero tariffs and zero quota trade in physical goods between the UK and the EU. So, I think that's going to be a very, very basic skinny trade deal.

HP: So if a deal cannot be reached, and you mentioned that is certainly a possibility, talk us through the practical implication for businesses.

PG: Absolutely, we’ll look in a no-deal scenario. There’s just one thing to note; the Prime Minister would often talk about an Australian-style deal. What that is a slight cover for is a factor in a no-deal scenario where we will revert to World Trade Organisation (WTO) standards. And that will come with disruption. There’s going to be a new range of tariffs and quotas on goods and that will take time to bed in. We don't have a lot of time to do this. There's potentially some friction when it comes to travelling to the EU going forward.

There is, of course, the very sensitive issue of what happens to UK fishing waters and we saw some quite dramatic headlines about that over the weekend. There will be disruption obviously in a no-deal scenario but, that said, just one thing to reflect upon, even if we get a deal and of course that deal theoretically should have zero tariffs and zero quotas so that's a good thing but on a range of other issues, it is still a new relationship with Europe.

There will be other implications, even if we get a deal. So, deal or no deal, there's going to be change but, a no-deal would be more problematic and create a lot more friction in the short-run.

HP: Well thank you Peter for your insights today. The one thing we've always known about Brexit is the negotiations would go down to the wire. It certainly appears a deal is still possible, but it's far from inevitable. We should also know from an investor impact, leaving the EU feels like a dramatic moment for the British people. We should remember that UK economy only accounts for less than 5% of global output and is only a small part of the investment universe.

As always the best way to navigate political and economic uncertainty is through a globally balanced, diversified portfolio held for the long term while taking advantage of tactical opportunities.

Beyond Brexit, investors were consumed last week by the grim virus data, stimulus impasse in Washington, along with further policy support for Europe. The bitter battle between surging coronavirus figures and improving vaccine hopes continued to play out, with numerous countries reporting a rapid rise in infections, hospitalizations and deaths.

The coronavirus killed a record 3000 people in a single day in the United States (US) last week. The US looks set to pass the 300,000 death rate during the course of this week. As a result, restrictions are being intensified around the world. Germany is likely to go into a hard lockdown from Wednesday.

But the vaccine hopes are still shining bright. Inoculations in the western world started last week. Tuesday was V-day in the UK, as mass COVID vaccinations began. Other countries are racing to approve vaccines. The FDA approved Pfizer's COVID-19 vaccine for emergency use on Friday. Forecasts are that the US and Europe will be herd immunity levels by the time we get to the third quarter of next year.

US stimulus optimism continued to oscillate last week. US Treasury Secretary, Steven Mnuchin, and House Speaker Pelosi said progress has been made, although the two sides continue to clash over business liability shields as well as aid for state and local governments. With lawmakers close to packing up for the Christmas break, this week represents the last chance of a deal for the year.

In Europe the focus is on the European Central Bank (ECB) and the European Summit. The ECB is under pressure to try and protect the eurozone from a double dip recession. They extended its pandemic emergency purchase programme by €500bn and nine months, to at least the end of March 2022.

They also committed to reinvestment until 2023 and extended the targeted long-term refinancing operation by another year, although Christine Lagarde, President of the ECB, tried to rein in expectations by warning they may not use all the new ammunition if favourable financing conditions can be maintained.

At the summit, EU leaders persuaded Poland and Hungary to accept tying funding to the rules of law, paving the way for the implementation of the seven year €2.2trnbudget and the €750bn pandemic relief package. Although, the agreement still needs to be ratified by the European Parliament. In terms of the impact, the extensive monetary and fiscal support should help with the European recovery.

The mutualisation of debt is an important step and helps to reduce fragmentation risks in the eurozone. However, the path to reflating the economy and recouping lost output in the eurozone is likely to be a long and arduous one.

In terms of the week ahead, the focus will be on the Federal Reserve’s (Fed) meeting on Wednesday. In August, the Fed adopted the new flexible average inflation targeting framework. Then in September the central bank transposed those principles into its forward rate guidance. The Federal Open Market Committee (FOMC) is now settled into more of a ‘wait and see’ mode, as it monitors the outlook and assesses the need for additional policy support.

Given the outlook the policy rate is widely expected to be on hold through 2023, with the FOMC having pledged to keep rates on hold until the shortfall from full employment has been eliminated and inflation has surpassed the 2% long run target, as on course for a moderate overshoot.

The November FOMC minutes indicated there is a consensus within the committee to make changes to forward guidance regarding the path of asset purchases but no appetite for altering monthly pace of purchases or the composition of those purchases.

Markets will also be watching the Monetary Policy Committee (MPC) meeting on Thursday. Whilst we do not expect any further reduction in interest rates at this stage, negative rates still remain a possibility in the UK as the Bank of England wrestles with the worst economic growth in 300 years, rising unemployment and, of course, that Brexit uncertainty.

The UK unemployment rate, as we know, has remained fairly low while furloughed workers are classed as employed. The extension of the furlough scheme until March 2021 should keep the UK unemployment rate fairly stable until then. Therefore, Tuesday’s October data is unlikely to show a great change in unemployment although we do expect a small uptick and vacancies to remain at record highs.

And with that I'd like to thank you once again for joining us. We hope you found this podcast interesting and informative, and it's given you a guide to the key Brexit negotiating points and the potential impact a no-deal Brexit will have on businesses. This is the final instalment for this year The series will start up once again in early January, but for now may I wish you every success for the trading week ahead.