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CROSS ASSET WEEKLY
11.10.2019

Brextensions to keep Gilt yields under pressure

Summary
Cross asset weekly pic
A few positive words from the Irish Prime Minister following a meeting with its British counterpart sent the pound and gilt yields sharply higher yesterday. Indeed, Leo Varadkar said that he could see “a pathway to a deal”. It’s hard to think what could have been said to prompt this optimism. The key sticking point remains the border on the island of Ireland, which the ‘backstop’ was supposed to solve but that Boris Johnson rejected. His plan, to keep Northern Ireland in the UK customs union but avoid a physical border in Ireland, is simply unrealistic if it wants to fulfil all the conditions (open border, the Good Friday Agreement and the integrity of the Single Market). We very much doubt that he came with a new brilliant idea that solves this dilemma.
Whatever was said at that meeting, we think that the most likely outcome at the end of October is for Brexit to be delayed again, prompting a general election. In other words, Brexit uncertainties are likely to persist for a while longer. There are growing signs that these short extensions to Article 50 are increasingly damaging the UK economy. We expect the Bank of England to lean against this and cut its policy rate by 25bp over the next 3 to 6 months.
Looking further ahead, this raises the question whether UK bond yields could be the next ones to dive into negative territory. While persistently high Brexit-related uncertainties will keep bond yields under pressure, it would likely take an economic shock such a hard Brexit for Gilt yields to turn negative on a sustained basis.
In a separate piece, we look at equity styles and conclude that quality stocks are more attractively valued than momentum and growth stocks. They also tend to outperform the overall market over the medium to long term. Thus we would overweight quality stocks in a portfolio. Anaemic economic growth warrants holding growth stocks, while signs of economic turnaround in Asia justify some targeted value exposure.

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