Giles Coghlan, chief currency analyst, HYCM, looks at areas of potential impact should a No Deal Brexit look increasingly likely.
Brexit is almost upon us. Four years after the initial referendum, the UK is set to finalise its departure from the EU on 31st December 2020.
However, even after all this time, we’re no closer to actually knowing precisely what the UK’s future relationship with the European bloc will look like. Prime Minister Boris Johnson’s Internal Market Bill last December may have outlined the UK’s future political relationship with the EU; however, the UK’s ability to access the consumers and investments present in the European Economic Area (EEA) remains undecided.
Commentators and EU officials were already skeptical about the UK’s ability to negotiate a future economic relationship with the EU in under a year, and that was before anyone had heard of COVID-19. Over the course of the year, the economic disruption caused by the pandemic has resulted in both the UK and the EU edging closer to COVID-induced recessions. Despite this, the UK shunned suggestions to extend the Brexit transition period, potentially fearing internal revolt from within the governing Conservative party.
The outlook is that a deal will be reached between the EU and the UK within the next few days. However, a breakdown of negotiations and the UK leaving the EU on World Trade Organisation (WTO) terms cannot be completely ruled out. Although Boris Johnson is planning a ‘significant Brexit intervention’ in a last ditch attempt to progress negotiations, a no-deal Brexit remains on the table.
So, for investors wishing to avoid any Brexit-related disruption to their portfolio, what assets are likely to be worst-hit by no deal volatility?
Taking a pounding
First and foremost, the UK exiting the EU without a deal would precipitate an immediate devaluing of the pound. Given that the value of the sterling slumped to a 31-year-low following the initial referendum result, the level of devaluation following actual culmination of Brexit may be considerably deeper. An immediate test of 1.2200 on the GBPUSD would be a first target for sellers.
As such, we are likely to see UK-based investors performing a range of actions, from exchanging liquid sterling for Dollars or Euros, or potentially setting up a currency forward contract. It is these types of actions that could minimise the disruption caused by a volatile pound in the months following Brexit. Of course, some companies would actually gain from a weaker pound against the USD if their earnings are mainly in USD.
No deal like the old deal
In terms of UK-based stocks and shares, there are definitely certain sectors more vulnerable to Brexit disruption than others.
Most notably, UK-based technology and fintech firms will face an abrupt end to the unrestricted flow of data between the UK and the EEA following a no-deal exit, significantly curtailing their ability to scale and enter into new markets.
The UK’s digital economy, subsequently, would likely immediately shrink following such a scenario. Investors who’ve previously purchased shares in UK-based tech firms are naturally considering the impact this will have on their holdings. Research from the New Economics Foundation and the UCL European Institute have estimated that this disruption to the flow of data could cost such firms upwards of £1 billion.
UK-based assets are likely to incur some immediate devaluation following a no deal; however, as outlined above, liquid sterling assets and UK-tech-shares are by far the most vulnerable. Investors must properly evaluate the future health of their portfolio if heavy in these two asset classes, potentially consulting with a currency specialist to hedge against Brexit-related sterling fluctuations or investing into USD-based exchange-traded funds.
Of course, the expectations are that a deal will be agreed upon, ratified, and implemented before December 31st with the UK’s access to the EEA remaining mostly unaffected. There are reported to be a number of investors who are just waiting for a deal to be ratified before purchasing UK assets again.
Regardless of the outcome it is important for investors to be prepared for all possible scenarios that could transpire on 31st December, be it a no deal Brexit, an agreed withdrawal transition plan, or even an unlikely extension of the current deadline.
