For several years now, deep uncertainty about Brexit has taken its toll: UK related economic data and asset markets have been out of sync with the global cycle and the UK’s major trading partners, including the euro area. That could change in the wake of the recent British election, which delivered a strong majority for prime minister Boris Johnson’s Conservative party and a firm mandate for the UK to leave the EU at the end of January. The current government has passed bills that aim to prevent extending the transition period before the UK exit. Along with delivering some new clarity about next steps for Brexit, the election results increase the likelihood of fiscal stimulus in 2020. Moreover, by removing the risk of a government led by Labour’s Jeremy Corbyn, has reduced the extreme tail risks for corporates, and hence, removing that idiosyncratic risk premium built into UK assets. 
Undoubtedly, political uncertainty should persist over 2020. But the passage of the current government’s Withdrawal Bill, setting a clear date for an end of January exit, coupled with strong political support for Brexit should provide some near-term clarity. We are already seeing this improvement in sentiment in RICS and Deloitte CFO survey data and the latest REC employment survey. These events increases the potential for some recoupling of the UK’s economic prospects with those of the euro area and the global cycle.
For the first time in 18 months we are seeing more clarity on the economic outlook. Among the causes: diminished political uncertainty after the decisive election outcome; fiscal stimulus from the Treasury which is set to boost growth by least 0.3 per cent this year; and, finally, improving data flow in the euro area – especially in the manufacturing sector. These factors underpin our expectation for a near-term pickup in sentiment and activity data in the UK.
But investors are right to ask: How durable is a post-election recovery? That remains an open question, which will be fundamental to taking a view on UK assets over the coming months. For UK related assets, one issue is key: Whether the fiscal impulse replaces weak growth or is adding to growth – basically whether the fiscal impulse is procyclical or not. All else equal, strong fiscal spending in an improving economy would be supportive for a more sustained recovery and will coincide with higher gilt yields and a stronger currency. We would also expect that if stimulus is procyclical, it should boost equity market performance – especially in domestically oriented sectors.
Until recently we had assumed that the monetary policy outlook would be relatively stable; clarity provided by the decisive election should have reduced the chances that the Bank of England would stimulate the economy via rate cuts. But recent BoE commentary has turned dovish, and the pivot appears to have come as UK economy decelerated into the end of the year. Essentially, the BoE’s Monetary Policy Committee (MPC) is seeing weakness in the economy as a reason to take pre-emptive, insurance-like action to stem a decline in economic data.
At the time of writing, markets are pricing a 60 per cent chance of a rate cut in January and further easing thereafter. We find it difficult to see the Bank delivering what markets price against the backdrop of our economic outlook and the fiscal stimulus proposed by the current, newly energised government. While over the near term there is considerable uncertainty on the outlook for gilts, ultimately we see gilt yields rising as fiscal stimulus is implemented and as economic data improve modestly.
The currency remains the main channel to express views on economic uncertainty. The surprise at the start of this year is how resilient pound sterling has been in the face a sharp pivot from the Bank of England and the corresponding fall in bond yields. Given our view that the market is priced aggressively for rate cuts, we see a near-term upside for sterling vs US dollar. Over the medium term there is limited room for GBP to rally as future negotiations with the EU will remain fraught and it is difficult to see a proper trade agreement coming together over the short transition window of just 11 months. The UK FTSE 100 equity market screens as cheap on many metrics, but the market’s earnings profile has been poor and expected to remain so based on analyst forecasts. From a global asset allocation perspective, a firmly neutral stance on the FTSE 100 equity index seems most appropriate.
Thushka Maharaj, is a global multi-asset strategist at JP Morgan Asset Management. The views expressed above are her own and should not be taken as investment advice.