Would the market shock force Parliament to seize Brexit?

LONDON (Reuters) – There's nothing like a stock market crash to get the attention of politicians and Prime Minister Theresa May may find that only a sharp fall in the price of British assets can convince a divided parliament of support its agreement on Brexit.

But how much do investors have to account for in pounds sterling and equities before legislators decide that a "no agreement" exit from the European Union should be avoided?

Hopes that Parliament rejects the withdrawal agreement reached in May by the European Union have prompted investors to start buying protection against a drop in the pound sterling and implied market volatility measures are in rise.

Until now, however, there is nothing to suggest this type of financial market slaughter that could tip pro and anti-Brexit MPs behind the May deal, for fear that Britain will not sort of block March 29 without transition provisions.

This suggests that investors always see a form of negotiated exit as the most likely outcome.

The Bank of England warned that a "no deal" scenario would be an economic shock similar to the oil crisis of the 1970s.

"In what could be concentrating the minds of politicians, one would have to witness a significant drop (in asset prices) – more than last week," said Robin Marshall, director of fixed income securities for the company. Smith & Williamson investment.

He estimated that a fast move between 5 and 7% in sterling and that the stock market would provoke a reaction.

Parliament is expected to vote on the agreement from May to mid-December. If a multiparty opposition defeats its projects, the risk becomes real that the Brexit becomes "no agreement" by default.

This could result in former government adviser Rupert Harrison, currently a portfolio manager at BlackRock, calling it a "TARP model": the ensuing stock market crash would see lawmakers quickly abandon opposition to May's deal. and approve it on the second attempt with minor changes.

For a chart on Market Market and TARP, see – tmsnrt.rs/2R5Djd8

TARP refers to the Troubled Asset Relief program, a US government initiative to bail out banks at the height of the 2008 financial crisis. The TARP rejection by the House of Representatives on September 29 led to a fall of nearly 10% on Wall Street. The house turned around four days later.

Other parallels of this type abound. Greek Prime Minister Alexis Tsipras, elected in 2015 to remedy the austerity imposed by the European Union, has kept his campaign promises as the fall of the markets threatened the Greek banks.

In May, the largest sale of Italian bonds in 25 years forced two conflicting political parties to form a coalition government, with politicians striving to reaffirm Rome's attachment to the euro.

For a chart on the market and Italy, see – tmsnrt.rs/2R3YbBn

"Do not shock enough"

Closer to home, there was the "Black Wednesday", the day in 1992 when Britain was excluded from the European Exchange Rate Mechanism (ERM) mechanism, a precursor to the European Union. euro, after that she could no longer defend the pound sterling against speculative attacks. The crisis has forced the authorities into a brutal cycle of rising interest rates.

A "hard" Brexit could cause a similar economic disaster. UBS calculates that Britain would lose 10% of its output and only get a little better with a moderate deal (6%).

But it will be the sterling that will occupy a central place if the TARP model is to save May – his game plan according to some, although others consider it a wishful thinking. They argue that the market fluctuations already observed since the June 2016 referendum have done little to change the legislators' view of Brexit and its form.

"In my opinion, the pound sterling is facing more pressure to become part of chaos," said Salman Ahmed, chief investment strategist at Lombard Odier.

Ahmed estimates that in an uncompromising scenario with Brexit, the pound would slip by an additional 10 to 12%. That would leave the pound close to $ 1.13, its lowest level in more than 30 years.

"In Greece, for example, the difficulties in the market, especially in the banking sector, contributed to the resolution of the compromise of Alexis Tsipras. I do not see that happening at the moment in the UK because it has not been shocking enough, "he said.

Observers note that recent movements in sterling have been limited, although they appear dramatic. On September 21, when the EU rejected the Mayers Checkers' proposals regarding meetings after Brexit, the pound fell 1.7%. It slid 2% again on November 15, when ministers resigned following last May's deal.

This compares to a 7.8% dip against the dollar on June 24, 2016, the day after the Brexit referendum.

Growing expectations that Parliament will reject the May deal could themselves undermine the TARP scenario if a first failed bill is priced in the markets.

For a chart on the recent pound sterling, it is unlikely that the vote on Brexit will be reflected in the following outcome: see – tmsnrt.rs/2R5kMhb

The relatively circumscribed movements so far reflect investors' belief that a smooth exit, or even a second referendum, is more likely than a dead-end disorder. This made them be wary of selling the pound sterling, fearing a huge rebound in the undervalued currency if an exit agreement is reached.

Instead, they used derivatives rather than cash markets to take positions.

There are signs that if things start to get really bad, other classes of people will feel it too.

Last week, when it became apparent that the ministers were mobilizing to overthrow May, the inverse correlation between the FTSE and the British pound evaporated – a rare occurrence of the currency and the decline of UK equities.

It also gave a glimpse of the general economic chaos. Real estate stocks have fallen sharply, raising fears that the housing market, the depository of wealth for most Britons, will suffer. Banks' shares also fell, recalling the collapse of Northern Rock in 2007.

For a chart on sterling FTSE correlations November 22, see – tmsnrt.rs/2R3YgoF

"Character of foreigners"

Most investors are reluctant to choose a particular level that would persuade politicians to agree on an agreement. But the rush of options markets to protect against further declines in the pound shows that nervousness is growing.

BNY Mellon's strategist, Simon Derrick, expects the stock to spread around the world, as liquidity is reduced as the year-end vacation approaches. .

"This is when volatility begins to affect international markets," he said, citing the period from December to January, after which, after a first unsuccessful attempt to get it through parliament, the government had a short time to try again.

A rout in the pound is risky because the UK, according to Bank of England governor Mark Carney, is facing a large deficit in its current account and is dependent on the "kindness of foreigners" or foreign investments to pay his bills.

The devaluation of the pound sterling since the 2016 referendum has reduced the deficit, but it remains at 3.9% of GDP.

Ben Lord, a UK fund manager at M & G Investments, said the situation was similar to that seen during the ERM crisis or Britain's 1976 bailout by the IMF. International Monetary Fund.

"We do not want a catalyst where we see these foreigners, these sources of foreign money stop funding us. That's when we get a very large devaluation of the pound sterling. "