Investors’ nervousness has increased slightly following record highs (S&P500, Nasdaq, EM Asia) due to the continuing lack of Brexit clarity and weak economic data on both sides of the Atlantic
Effective vaccine/s against Covid-19, are anticipated to start being deployed soon. In the event, UK medical authorities approved the Pfizer/BioNTech’s candidate and inoculations are programmed to commence on Tuesday (December 8th). US medical authorities are expected to follow suit even as soon as late in the current week, with the review of Moderna’s candidate to conclude about a week later. European medical authorities are set to conclude their review of the Pfizer/BioNTech’s vaccine on December 29th and Moderna’s by January 12th. As a result, expectations continue to strengthen for a sustained, robust, recovery of the global economy, past the next few months in which the ongoing 2nd wave of the pandemic is set to depress activity. According to OECD estimates, global real GDP will rebound by +4.2% yoy in 2021 after contracting by 4.2% yoy in 2020, followed by an also robust +3.7% yoy in 2022.
Meanwhile, negotiations between the European Union (EU) and the United Kingdom (UK) regarding their post-Brexit relationship continue, with an agreement appearing to hang in the balance. Recall that the current transition period of maintaining the pre-Brexit status quo, expires as of January 1st 2021. Thus, time is of the essence, so as for economic agents and particularly corporations and public authorities to be as prepared as possible for the new administrative, regulatory and customs requirements which will apply on trade and, consequently, for supply chain disruptions to be alleviated. Notably, the trade between the UK and the EU, represents a large portion of their individual overall trade, particularly for the UK. Indeed, exports (of goods and services) to the EU, account for 43% of total UK exports (c. half of which, regards services). At the same time, imports from the EU, represent 52% of total UK imports. In all, according to the UK Office for Budget Responsibility (OBR), the short-term hit on the UK GDP by the disruptions caused by a potential no-deal Brexit (and with little time to adjust to the new regime), amount to c. 2%. In that context, a short-term extension of the transition period should not be ruled out.
Apart from the short-term effects on economic activity from a potential disorderly transition to the post-Brexit trade regime (which are expected to dissipate gradually), the long-term Brexit impact is not negligible. That impact stems, inter alia, from: i) lower business investment in view of a possible loss of export markets shares due to increased costs and; ii) the longer-run consequences of investment being delayed or cancelled. Drawing from a wide array of pronounced respective studies (including from the OBR), the average estimate for the long-term impact on GDP of the EU and the UK failing to reach an agreement and as a result trading under World Trade Organization (WTO) rules, stands at -5.9% (in comparison with Brexit not taking place at all) and at -0.8% for the EU. Repeating the same exercise under the assumption that the EU and the UK manage to reach a “typical” Free Trade Agreement (in which tariffs and broader trade barriers are significantly less compared with the WTO scenario but also meaningfully higher compared with the pre-Brexit status quo), the average estimated long-term impact on the UK GDP is reduced to c. -4.0%.
In all, investors’ risk appetite remained robust in the past week, albeit deteriorating slightly in the last trading sessions. Global equities and speculative grade corporate bonds largely continued to post gains, with the MSCI ACWI index up by 1.5% wow (+12% ytd). The FTSE 100 over-performed, with the UK being the first western country to approve a vaccine against Covid-19. At the same time, high yield corporate bond spreads narrowed by 32 bps to 403 bps in the USD spectrum and by 21 bps to 350 bps for EUR bonds. In foreign exchange markets, the downbeat officials’ comments since the past weekend regarding the progress in Brexit negotiations (and the prospect of an agreement being reached before the upcoming European Council on December 10th -11th), led the British Pound down on Monday (-1% in nominal effective exchange terms) broadly reversing past week’s gains.