Friday, 13th of December 2019
“It is easy to make promises; it is hard work to keep them.”
– Boris Johnson
Johnson’s Conservatives romped home with a massive 80-seat majority in the UK general election this week promising to ‘Get Brexit Done’ after three years of intense political wrangling. This straightforward message resonated with a weary public, and particularly in Leave-backing post-industrial constituencies in Northern England, Wales and the Midlands where voters were fed up with waiting for Parliament to deliver Brexit. Many of these seats comprise the traditional Labour heartlands, a so-called ‘Red Wall’ of working-class towns and former coal pit villages where voters have backed the Party for generations. However, Labour’s deeply unpopular left-wing leader Jeremy Corbyn and its failed triangulation since the EU referendum – an attempt to keep both Hull and Hampstead on side – were soundly rejected by voters on Thursday. The results for Labour are stark, with some constituencies such as Don Valley in South Yorkshire falling to the Tories for the first time since 1922. In other once safe Labour seats like Great Grimsby, Bassetlaw and Dudley North, the Tories have overturned decades of party loyalty and secured majorities in excess of 20% (i.e., some of their largest anywhere in the country). Across the UK as a whole, the Conservatives have won their largest number seats since Thatcher’s landslide in 1987 while Labour has held on to fewer than at any time since 1935.
Although the scale of the defeat for Labour has come as a shock to many commentators, working-class voters outside the major metropolitan centres have been drifting away from the Party for some time as it struggles to convince them that its cosmopolitan MPs and activists share their concerns and values. (This has, of course, been a common theme across Europe where centre-left parties have crumbled in recent elections and, in some countries, have disappeared altogether.) If the Conservatives can keep these voters onside once Brexit is settled, they will be in power for many years to come. To do so they will need to invest more in infrastructure and public services. We therefore expect a fiscal stimulus to be announced in the first Budget of the Johnson government, which would be positive for UK assets and rates even if many details of the future trade relationship between the UK and EU remain uncertain. In the medium-term, the UK government is likely to prioritise investment in ‘left-behind’ areas and has plans to create a large number of Free Ports (where imports face few regulatory and no tariff restrictions) in an effort to rebalance the UK’s lopsided economic geography. This should be positive for growth and is unlikely to spark higher borrowing costs given the significant reduction in the UK’s fiscal deficit under Johnson’s Conservative predecessors. It is also likely to attract private investment that has avoided the UK over the last three years of political instability and Brexit paralysis.
Finally, the election result has important implications for the Brexit process and the nature of the future relationship between the UK and EU – something the two parties will seek to define next year. Crucially, Johnson’s large Parliamentary majority gives him room for manoeuvre on the terms of any deal and on how to approach the negotiations (i.e., whether to keep ‘no deal’ on the table). Given his now more pro-Brexit and working-class support base, we do not expect Johnson to seek a closer relationship with the EU than is outlined in the Political Declaration (i.e., no customs union or single market). However, given the economic benefits to both sides of maintaining close ties beyond January, and the absence of tariff and non-tariff barriers at the present time, we expect at least a bare-bones deal to be possible by the end of the transition period in December 2020. Whether Johnson thinks that the potential political cost of an extension is a price worth paying for a more comprehensive deal is unclear. But with his ‘stonking’ majority, it is now up to the PM alone to decide any and all Brexit trade-offs. This decision-making clarity will please the EU even if it means a more robust UK government approach since it avoids an accidental ‘no deal’ outcome and gives EU officials confidence that UK positions will not change radically based on the latest chicanery in Parliament. It will also increase investor confidence in the UK: sterling jumped as high as 1.35 after the exit poll revealed the scale of Johnson’s win, before paring back some gains. We see a volatile few months of EU-UK negotiations ahead, and a major confrontation between the UK government and SNP over Scottish independence as likely, but the UK political outlook is on the mend.
Across the pond, positive news on trade drove markets this week. Firstly, on Tuesday, the Democrats reached a deal with President Trump to support a revised USMCA (i.e., his NAFTA replacement) after he agreed to strengthen labour and environment rules applied under the deal. Hours later it was ratified by the three country parties – the US, Canada and Mexico – ending uncertainty over the future of trade in North America. Although the deal is not that different from NAFTA, its conclusion is a win for Trump given protections for the US auto industry and is welcome news for investors. Secondly, on Thursday, the President suggested that he had now signed off in principle on a phase-one US-China trade deal. Reports claim that China has pledged to buy more US farm products in exchange for a delay to the 15 December tariff hikes. If so, then this interim deal is pretty thin gruel and does nothing to address any of the underlying structural concerns that the US has with how China conducts its trade and economic policy. However, markets are happy if it signals an end to the current phase of the US-China trade war. Maybe that’s all we can hope for at this point.