Brexit Black Friday On April 12th

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Includes: DBUK, DGBP, EWU, EWUS, FKU, FLGB, FXB, GBB, HEWU, QGBR, UGBP
by: Peter Cooper
Summary

Brexit battle in the UK now reaching a climax.

No-deal scenario with full Brexit on April 12th now most likely option.

Financial markets completely unprepared, still pricing in a transition deal.

Hugely overvalued stock markets about to hit the wall.

Brexit is the next Lehman Brothers or Black Swan event.

Black swans are unforeseen events that crash overvalued financial markets. The Black Friday for a "no-deal" Brexit is fast approaching on April 12th, unless a near-miraculous last-minute deal can be reached. Nobody is preparing for the worst, but this is now the most probable outcome in financial markets, almost the definition of a Black Swan event.

I'm sure most American readers, and their British counterparts too, have given up trying to follow the interminable political wrangling over Britain's attempt to leave the European Union as directed by a 52:48 referendum win nearly three years ago. But that is the main reason why the danger is so widely misunderstood at this critical juncture - with less than two weeks until the default "no-deal" Brexit. This article is going to try to wrap this up in language easy enough to understand without totally losing the plot.

Political paralysis

This is where we stand this weekend. The British Prime Minister has failed three times to get a Brexit transition deal passed by lawmakers in the House of Commons. Last week, the same MPs voted on eight different options to progress the Brexit debate and decide what to do next, and every one of those was defeated. The British political system is completely paralyzed over the Brexit and hasn't got a clue of what to do next.

Next week, more attempts to clarify this position will likely be made, narrowing options to try to come up with at least positive guidance for the hapless UK government led by Prime Minister Theresa May. In order to avoid the so-called hard or "no-deal" Brexit on April 12th now fixed in the calendar, she will have to present her 27 EU opposite numbers with a valid reason for an extension of this date. This comes down to two options, namely a general election or a second referendum.

Both options are fraught with hazard for Mrs. May and her party. Senior figures in the Conservative Party are warning this weekend that their hopelessly divided party would lose a general election. Indeed, 170 of her MPs, including several ministers, signed a letter this week calling for a "no-deal" Brexit on April 12th, while about the same number support are against it.

The chances of such a fractured party emerging victorious from an election does indeed look slim.

Second referendum?

Holding a second referendum with her party so split is also highly undesirable from the perspective of holding on to power in the longer term, although it might see her over the short-term problem better than an election. However, it would also mean the UK holding the scheduled European Parliament elections at the end of May. As Mrs. May correctly points out, this would be hard to explain to a British electorate that voted to leave the EU almost three years ago, and would be highly divisive.

From the European side, the Brexit has become a massive embarrassment, and is also an overwhelming political issue if it continues to rumble on while the European Parliament election takes place. The risk is a rise of the nationalists across Europe in this election, while if the "no deal" Brexit happens on April 12th and the expected chaos follows, then voters will rally around the EU flag. This is perhaps the real reason why the EU leaders gave the UK only a short extension to the Brexit deadline at their last summit meeting.

Preparations for the "no-deal" Brexit are now being ramped up, with the French and German leaders due to meet the Irish Prime Minister Leo Varadkar about the controversial Irish border issue. Ironically, given that even a backstop of restoring the border was the downfall of Mrs. May's deal, the "no-deal" will immediately require an Irish border to collect EU tariffs from Northern Ireland and vice-versa. See here.

On April 12th, unless a miracle happens, the UK will crash out of the European Union, of which it has been a member for 46 years. The Bank of England has somewhat backtracked on its most extreme predictions of the economic impact of a "no-deal". But nobody is expecting a smooth ride if this happens, and remarkably few people in financial markets are taking this seriously even now at this late hour.

Investment implications

Expect to see the pound sterling dive in value and the euro to take a plunge against the US dollar. This will clearly further damage US trade with Europe, already imperiled by the slowdown in business of Germany. See here.

The stock markets in Europe will drop. Will there be immediate contagion across the Atlantic? If not, then further overvaluation of the greenback and US stocks is probably not to be welcomed either. Articles warning of the unprecedented overvaluation of US stocks are increasingly seen on this website, for example "U.S. Stock Market: Recession Ahead?"

What would certainly be evident is heightened volatility and unpredictable lurches in all sorts of financial markets. Would commodity prices rise with the US dollar or fall with the depression of European business and consumer spending? Is gold or oil a safe haven in such a scenario? Moreover, you have to ask what shocks would emerge from the backrooms of global finance. Usually, unexpected events have unexpected consequences.

When the plug was pulled on Lehman Brothers before the Great Recession, nobody in the US financial establishment envisaged the global mayhem and near-Armageddon that would follow. Isn't there a danger that a similar error is being made now by the EU with the "no-deal" Brexit?

In the meantime, the time to hide in safe havens is surely now and not when the Brexit party is really over on April 12th. I'm still praying for a miracle.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.