• Great Britain’s formal notice of intent to depart from the European Union represents a defining moment in its history, but comes as no surprise to markets.
   
• The European Union will probably take a hard stance in negotiations in an effort to deter other countries that may be considering a departure and because it will likely take a lesser economic hit than Britain.
   
• We expect Brexit headlines will continue to create noise and induce short-term emotional reactions, which may present opportunities for disciplined long-term investors.

Prime Minister Theresa May has expressed a preference to pursue both negotiations from the outset, while Michel Barnier, the European Commission’s lead negotiator, intends to conclude the first of the two before attacking trade.

The expectation that the EU will take a hard stance seems fairly certain at this stage; squeezing Britain would enable the group to send a strong message to any other countries considering a departure. Furthermore, Britain’s economy would probably suffer more in the absence of a deal, since default trade terms would raise export tariffs and barriers to services at the core of the nation’s economy.

Nevertheless, the possibility remains that May could choose to walk out of negotiations altogether in an effort to save face and retain a degree of national pride. 

The Economy, Sterling and Monetary Policy

Prior to triggering Article 50, economic momentum has been strong in Britain, and the declining value of sterling has lent short-term benefits to some U.K. exports. The flipside of sterling depreciation has been a jump in inflation, albeit lower than expected, as importers relied on hedges and diminished margins to temporarily shield U.K. consumers from price increases.

European Union (EU) leaders received perhaps their most consequential piece of mail in decades on March 29, 2017: Great Britain’s invocation of Article 50 — the formal commencement of a process by which a member state leaves the EU — representing a defining moment in the country’s history.

But the action itself, as well as the range of options that may follow, had been telegraphed exhaustively months in advance; so there is no new information to digest. There was therefore no serious impact on markets in the immediate aftermath of the news; investors had already priced in a so called hard Brexit (that is, departure from the trading bloc).

Divorce Negotiations

The prevailing uncertainty since the Brexit referendum vote last summer can be expected to continue until we get clarity on the negotiation process. The European Council of government heads must first agree on negotiating guidelines before Britain meets with member countries (as a group) to settle on a process for negotiations, which will likely take place in mid-2017.

Two distinct negotiations will occur:

The first will primarily focus on finances and the future status of each area’s respective citizens, which is bound by Article 50’s two-year negotiating window. The second will centre on trade between the two areas, which could likely take longer.
 

This dynamic should conclude in 2017 (for the most part), which means price inflation will likely accelerate and hinder consumer-purchasing power. Indeed, we have already begun to see early signals to this end, and suspect sterling could continue to depreciate as negotiations get underway.Still, the U.K. economy is proving surprisingly resilient.

The Bank of England’s Monetary Policy Committee (BoE) will be presented with a difficult choice if prices begin to rise faster than wages and overall economic growth moderates. There is a good chance that — despite its price-stability mandate — the BoE would remain dovish, favouring growth over low and stable inflation, which would reinforce sterling weakness.

The BoE’s accommodative actions last summer in the wake of the referendum shock can be viewed with positivity; indeed, it demonstrated willingness and the ability to react quickly in order to dampen the volatility of economic conditions.

Looking out several years, the potential benefits of Brexit to the U.K. appear minimal; but the range of possible outcomes is broad given the array of factors that must be considered.

How Brexit Impacts Markets

Roughly 70% of U.K. company earnings come from overseas and, as such, depend more on the state of the global economy than conditions at home. For now, those conditions appear relatively robust.

Those smaller and mid-sized corporations that are tied more directly to local fortunes have struggled, and will likely continue to do so; although many have already been re-priced to reflect the new paradigm. These companies could, in fact, represent attractive buying opportunities for those willing to look beyond several years of negotiations. U.K. house builders recovered their Brexit losses quickly, yet remain vulnerable to both a slowing property market and the potential for rising rates (should the BoE decide to fight inflation).

Gilt yields have stabilised in recent weeks, suggesting that the market has digested the implications of Brexit. It’s possible to imagine higher gilt yields (yields move inversely to prices) as investors demand a higher risk premium for holding U.K. assets in the future. However, yields could fall if we experience a less likely but more extreme outcome and the economy slips into recession.

We expect Brexit headlines will continue to create noise and induce short-term emotional reactions —which may present opportunities for disciplined long-term investors.

Glossary

Dovish: Dovish refers to the views of a policy advisor (for example at the Bank of England) who has a positive view of inflation and its economic impact and thus tends to favour lower interest rates. 

Important Information

Past performance is not a guarantee of future performance.

Investments in SEI Funds are generally medium to long term investments. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. Additionally, this investment may not be suitable for everyone. If you should have any doubt whether it is suitable for you, you should obtain expert advice.

No offer of any security is made hereby. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application may be made solely on the basis of the information contained in the Prospectus. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Bonds and bond funds are subject to interest rate risk and will decline in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. Narrowly focused investments and smaller companies typically exhibit higher volatility. SEI Funds may use derivative instruments such as futures, forwards, options, swaps, contracts for differences, credit derivatives, caps, floors and currency forward contracts. These instruments may be used for hedging purposes and/or investment purposes.

While considerable care has been taken to ensure the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.

This information is issued by SEI Investments (Europe) Limited, 1st Floor, Alphabeta, 14-18 Finsbury Square, London EC2A 1BR which is authorised and regulated by the Financial Conduct Authority. Please refer to our latest Full Prospectus (which includes information in relation to the use of derivatives and the risks associated with the use of derivative instruments), Key Investor Information Documents and latest Annual or Semi-Annual Reports for more information on our funds. This information can be obtained by contacting your Financial Advisor or using the contact details shown above.

SEI sources data directly from Factset, Lipper, and BlackRock.