Brexit Update: The Sword of Damocles

What Is Going On?

• Boris Johnson is the new prime minister of the United Kingdom. Several Conservative MPs have already resigned, and more could follow. Johnson's speech tomorrow will be in focus, while he has already cleaned house and appointed new cabinet ministers, many of whom are hardline Brexiteers.

• We now see a higher risk of a no-deal exit. The chances of a general election and another delay to the October 31 deadline have also risen, in our view.

• We also now see no outcomes with a probability higher than 50%. "Deal" remains the base case, but not by much. A general election or another delay would further diminish the chances of "deal," in our view.

• Parliament will be on recess from July 25-September 3. In the meantime, Johnson's team will likely seek to renegotiate the withdrawal agreement with the E.U. We do not expect much success, at least at first.

• This will set up for a tense backdrop come early autumn. Expect Johnson to push for a no-deal exit—even if "no-deal" is averted, GBP could still come under renewed pressure heading into September.

Outcome Probabilities (NEW CHANGES)

1. The U.K. leaves the E.U. with a deal in place ("deal") Our estimated probability: 40% (previously 50%)

2. The U.K. does not leave the E.U. ("no Brexit") Our estimated probability: 30%

3. The U.K. leaves the E.U. with no deal ("no deal") Our estimated probability: 30% (previously 20%)

How and Why Did Our Probabilities Change?

• The most important change is a higher risk of a no-deal exit. We take Boris Johnson's no-deal threats seriously. Despite Parliament's best efforts, no-deal is still the legal default if no alternative path forward is agreed upon (see next slide).

• "Deal" is still the base case, but the probability is now below 50%. Johnson has a better chance of securing concessions or changes to the backstop than Theresa May, in our view, because his no-deal threat is more credible. That said, the parliamentary timetable is tight, and while Johnson may have a better chance for E.U. concessions, that does not mean he has a high chance. The threat of another delay could convince more Brexiteer MPs to vote for a deal this time around in hopes of avoiding the "no Brexit" outcome.

• The risk of Brexit being cancelled entirely is still very much possible. The risk of a general election has risen given the government's razor thin majority. A new election could pave the way for 2nd referendum. Several E.U. officials have signaled a willingness to grant another extension to the U.K., which could offer time for a general election/2nd referendum.

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