24/7 Wall St.

Tuesday, January 15, 2019, was a big but not so bright day in the United Kingdom. The British Parliament delivered a very wide defeat to Prime Minister Theresa May’s proposed Brexit deal terms. For the time being, at least, Britain will remain in the European Union. While this exit from the EU is an obvious defeat, the vote may not be what it initially seems to be. In some aspects it could lead to a worse or messier Brexit outcome, but there are continued uncertainties which have to be considered.

The big issue here as far as 24/7 Wall St. is concerned is that most Americans do not even know what Brexit really means, nor what Brexit really means to America itself. That was the result of a poll from Bookmakers.tv, according to Express in the United Kingdom.

We have been considering and preparing for Tuesday’s vote for some time. Here is brief, quick-hit attempt, with some observations and parallels in the United States, to explain what Americans need to know about the Brexit path going forward.

Prime Minister May had a loss in the House of Commons with a vote of 432 to 202. Some 118 members of May’s own Conservative Party voted down the proposed wording and terms of the existing Brexit plan. She had been working with her counterparts in the EU since Britain voted for Brexit in 2016 to secure terms on how to have an orderly exit from the union.

As of now, this vote against the current terms does not formally kill Brexit itself. That said, the other outcome now is that almost any scenario is on the table. The Brexit deadline is still just over two months away at March 29, 2019. The transition period, or grace period, is supposed to extend from that date through the end of 2020.

There are multiple issues to consider in the Brexit plan that was voted down on Tuesday. One issue is around hard border crossings with customs in Ireland. Another is to secure a trade pact between the United Kingdom and EU. Some politicians have wanted obvious assurances of a smooth and orderly exit after transition. Others have wanted the United Kingdom to stop paying into the EU and to be able to more easily set its own rules.

Tuesday’s vote could mean that Britain leaves the EU with no deal and no terms in place. That would be the “disorderly Brexit” scenario. If Britain leaves without a deal, there is some obvious fear that it would create serious disruption for travelers and businesses alike. Still, Tuesday’s vote ultimately could mean that Britain might back down and not leave the union at all, after a second referendum.

May spoke on Tuesday acknowledging the vote against her Brexit deal. She also was quick to point out that the vote made no efforts to put any new plans in place and had no path ahead of it. She still plans to pursue an orderly Brexit.

Jeremy Corbyn is May’s political opponent as leader of the Labour Party, and he has put up a vote of (no) confidence in May’s government that is expected to take place in just one day’s time (Wednesday). Most media outlets have signaled that May is likely to survive a vote of confidence because it would require members of her Conservative party to effectively side with Labour. In terms of the United States for a parallel, it would be like members of the Republican party saying there should be a Democrat leadership, or Democrats calling for Republican leadership. That’s why May is expected to survive a vote of no confidence. Yet, the vote on Tuesday was lost by such a strong margin that some people would be justified in questioning polls and media opinions now (which sounds familiar enough in America).

24/7 Wall St. recently pointed out that Germany was entering 2019 on the brink of what might get defined as a “technical recession,” without some of the classical fallout seen in past recessions (and certainly not the Great Recession a decade ago). While the effort is to sort out the United Kingdom in the Brexit process, there is a simple reason why this matters in the grand scheme of international trading: Germany had the largest weighting of the EU with 21.3% of total gross domestic product (2017, Eurostat), followed by the United Kingdom (15.2%) and France (14.9%). There is a lot of trade that could get disrupted with very few known mechanisms or remedies, and this could drag Europe down further.

Another consideration here is that the United Kingdom might have linked its economy with the EU, but it never did blend in its beloved British pound by adopting the euro currency. Germany, France and the other nations all adopted the euro as their currency. If Britain wanted to pursue a Brexit if it had accepted the euro and dropped the pound, this process would have been far messier, both in Britain and also in continental Europe. In some ways, it would be like trying to value the U.S. dollar without Texas or California in the economy.

How May goes forward with the Brexit effort by March 29 after Tuesday’s loss remains unclear. She could double down by insisting that the Brexit vote of the people needs to be carried out. She might also try to work on additional negotiated points with the Europeans. This remains an unknown as of Tuesday. But the Europeans on this same day made it clear that there is little wiggle room on what they had agreed to in November as their best deal for an orderly exit. Regardless of the changes proposed, if changes are pursued, it will require another vote in Parliament.

Another possibility is that May could call for a general election or for a second referendum. As of now, both of those efforts would create a delay to the formal Brexit date. It also would entail May putting her own prime minister job up for grabs. The decision on how to pursue the next strategy is widely expected to be this coming Monday, and a revised deal would come with yet another vote in Parliament within weeks.

According to multiple reports out of Europe on Tuesday, the EU will continue to prepare for the possibility of a “no-deal” come time for Brexit to occur. In short, the Europeans are at least preparing for the messy Brexit scenario.

One serious issue is that the United Kingdom is now in a fractured political state in the wake of Britain’s exit vote in 2016. From an outsider’s view, it seems hard to expect wording and terms that both parties can and will agree to. Again, compare this to any controversial issue between Democrats and Republicans in the United States, and then magnify it around sovereignty. Without a deal in place by the March 29 Brexit date, assuming that is not somehow delayed, that would mean that further trade agreements have to be reached with the members of the EU without any formal understandings and guidelines really in place.

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At least one prominent investment firm sees Brexit as a problem for U.S. equity investors. Merrill Lynch noted in the January 2019 RIC Report that the combination of the U.S. government shutdown, trade tensions with China and Brexit have created the perfect ingredients for a market rebalancing that it is currently addressing as a “baby bear.” The Merrill Lynch RIC report also discussed asset classes by country in its equity portfolio views, noting that concern over weak GDP growth and the Brexit fallout remain for the United Kingdom, and that concerns remain that the economic slowdown results in a recession. By its count, Brexit matters when adding it in with domestic issues inside the United States.

It seems obvious that American companies that conduct business in Europe and the United Kingdom have to pay close attention here. That is particularly true if they have offices and subsidiaries they operate in these countries. Mario Draghi, head of the European Central Bank (ECB), spoke on Wednesday, noting that Europe emerged from its crisis period just a few years ago. The problem is that the ECB really is not on strong enough ground to start raising interest rates in a manner like the U.S. Federal Reserve, which has pursued a move back to a neutral stance on interest rates. That said, the Federal Reserve has started winding down its balance sheet of $4.5 trillion to about $4.0 trillion, but the path for how and when the ECB can begin its large wind-down remains less clear.

Unfortunately, there are still more uncertainties than certainties on how the next step in the Brexit will go between now and March 29. This is a complicated topic, but we wanted to try to give an outlook for what may come down the road next.