Skip the battle of Brexit, try trading the Bank of England’s war


  • Business
  • Wednesday, 21 Nov 2018

NEW YORK: When it comes to Brexit, Columbia Threadneedle’s Ed Al-Hussainy sees no way to trade Theresa May’s quandary. So he’s focusing on Mark Carney’s.

The Bank of England (BoE) governor may not, like the British prime minister, face a mutiny among his colleagues, but he could be in for a messy confrontation with rate markets. As May struggled to hold her Cabinet together last week, fixed-income traders looked past Carney’s rate-hike signals and scaled back positioning for a move next year.

From Al-Hussainy’s perspective though, Carney will probably have to tighten policy and a yield spike could be on the way.

The pullback in market pricing showed that traders are focused on the growth risk from Brexit, the Minneapolis-based analyst said, and that they’re underestimating the potential impact on inflation due to factors such as currency weakness, higher import costs and reduced immigration.

For him, picking what the BoE might need to do is more predictable than whatever might happen in Westminster.

“We have no base case – we tried scenario analysis but it’s not working,” Al-Hussainy said of his team’s approach to trading Brexit.

“The moment we start assigning probabilities, we’re going to be wrong. Our people in the UK are too close to what’s going on, and we in the States are too far away.”

Traders are approaching a reckoning with monetary authorities on both sides of the Atlantic, with widespread doubts that policymakers can deliver the rate hikes they’ve signalled.

But Al-Hussainy, whose firm oversees about US$485bil, said Carney’s dilemma stood out. That’s because stronger price pressures in the UK give the BoE less flexibility to back off tightening than either the European Central Bank (ECB) or the Federal Reserve.

Markets may have to readjust to the prospect of higher rates soon, said Al-Hussainy, as the BoE is unlikely to significantly downgrade its growth outlook in its next set of economic forecasts.

He predicts that intermediate-maturity UK yields will rise relative to those in the US, because the BoE doesn’t have the same luxury of putting hikes on hold that the Fed has – especially if the British currency continues to slide.

Carney himself said earlier this month that if Britain were to exit the EU without a deal, it could cause a supply-side shock of rare magnitude that would push up inflation and warrant tighter monetary policy, even in the face of economic turmoil.

To complicate matters, Al-Hussainy said a no-deal Brexit could threaten the haven status of UK government debt.

“There’s a real risk that if you have a nasty Brexit outcome, this luxury will start to disappear,” he said. “And investors will demand a higher compensation to hold gilts.”

If the outlook for UK growth isn’t as bad as markets seem to be pricing, the same may not be true for risks to the euro region. James Athey, a money manager at Aberdeen Standard, said ECB policymakers are underestimating the potential blowback from Brexit.

“The negative impact of a disorderly exit is under-priced in the eurozone,” he said by e-mail. That could compound the impact from fractious politics surrounding Italy’s budget, and the unwind of quantitative easing, making it difficult for the ECB to deliver on its ambitions to raise interest rates next year, he said.

Athey is positioned for the euro to weaken versus both the US dollar and the British pound, and for money markets to price out policy tightening.

“These positions should all perform well in a bad Brexit outcome,” he said. — Bloomberg

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