A thread on Brexit. I retain the uncontroversial assumption that Brexit is an act of supreme economic, geo-political and societal self-harm. Here I focus on my concern that no-deal Brexit risks may be under-analysed and under-priced in the market. 1/
To start with the former gripe, I would characterise much Brexit analysis in the market as a case of “relax, it will be OK”. It reminds me of 2008 when all too many people belatedly realised that they needed to understand money markets. 2/
In terms of where we stand in the process, the “it will be OK” view seems simplistic given that the default is no-deal. Something has to actively change to prevent this outcome, and this is where the optimistic view often struggles for detail. 3/
Do people expect the EU to go-back on their decision to rule out a single market access for goods only and thereby allow a variant of the Chequers proposal, or will the EU back down on its implacable opposition to a N Ireland border? 4/
Equally, is the view that the UK govt will respond to the Chequers rejection by moving to the EEA option or accept a Canada deal with an add-on for N Ireland to remain in the single mkt, and is either outcome politically possible? 5/
I also see optimism on timing, with many expecting a last gasp deal. After negotiations end at the Oct EU Council meeting, avoiding a no-deal may require an A50 revocation or the EU extending A50 in the event of a UK election or new referendum. 6/
Despite the growing awareness of what a no-deal would entail, UK no-deal economic forecasts also seem a bit rose-tinted, with mild recession a common view. Imagine UK (and EU) PMIs when Brexit disrupts integrated manufacturing processes. 7/
Compounding this risk of optimistic analysis is the fact that the markets are not providing a notable risk premium to offset the increased potential of a hard or no-deal Brexit. 8/
To be fair, the cheapness of the GBP TWI reflects a lingering Brexit effect, but it has been mainly trading in a range for the past 12 months during a period when the odds of a hard/ no-deal Brexit have shortened substantially. 9/ 
The GBP TWI seems poised for a major move, which could come after the EU Council. Either GBP recovers a lot of its cheapness in the event of an EEA/ no Brexit outcome…10/
…or we get a large leg-down in the event of an extremely hard Brexit (Canada option) or no-deal. Assuming a stable DXY, it’s easier to see GBPUSD at either 1.50 or sub-1.10 than around 1.30 in 6 mths time. Events currently favour the bearish outcome. 11/
This sense of being between regimes is also reflective of Gilts. In an EEA/ no-Brexit scenario you’d expect UK growth to recover sharply and the BOE to bring fwd it’s plans to bring the base rate to neutral (~1.75%), taking Gilt yields with them…12/
…while into a no-deal, we’d likely be heading back to the 2016 Gilt yield lows as growth slumped and as the BOE focussed policy on the demand shock rather than an upsurge in imported inflation and put rates to their lower bound and resumed QE. 13/
The greatest concern regarding mkt pricing lies within credit markets where it’s hard to discern any real Brexit risk premium. In terms of IG corporate credits, the GBP spread over EURs is in line with post-2010 averages… 14/
…while the spread of GBP IG financials over EUR financials is below post-2010 averages. Whatever way you try and slice and dice the credit markets, a Brexit risk premium seems absent. 15/
Meanwhile, much analysis of equity mkts still emphasises the correlation between GBP and large-caps. But would a loss of mkt access implicit in a no-deal allied to a UK recession create an equity/ GBP de-correlation event/ trade? 16/
This is a rather long-winded way of saying that the asymmetry of risks in some UK markets does not seem appealing. Many are assuming that things will be OK and they may very well be correct, as it’s hard to have conviction on any outcome. 17/
However, it seems that in all too many cases this assumption has been reached with a good deal of embedded hope, and the mkts are not providing a risk premium to notably compensate for the increased risk of a no-deal. 18/
To finish with a tenuous silver lining: this icreates the risk of a notable re-pricing of UK mkts were no-deal to become a clearer outcome after Oct, which may (possibly) influence a political process currently heading in the wrong direction. 19/
