By James Mackintosh 

Just a few months ago U.K. Prime Minister Boris Johnson's Brexit deal with the European Union would have been as welcome to investors as a framed-photo handshake with Saddam Hussein. It brings more red tape for exporters, promises not to undercut EU regulations or labor standards and still might not make it through the U.K. parliament.

But the starting point is everything in markets. Just like the mini-trade deal with China being pushed by President Trump, it is less good than the last set of discussions, and worse than how things were before, but a whole lot better than no deal. Investors bid up the pound over the past week as the deal approached, although optimism faded a little on Thursday.

The jump in sterling as the deal neared amounted to a sigh of relief from markets. The pound is back up to EUR1.156, toward the higher end of its post-Brexit trading range, having been as low as EUR1.073 two months ago at the height of Mr. Johnson's No Deal rhetoric. It's also up strongly against the dollar, but the euro exchange rate offers a purer gauge of Brexit sentiment. The size of the rebound shows just how worried investors were that the U.K. would crash out of the EU at the end of this month without any agreement with its biggest trading partner.

Markets have been even more sensitive to U.S.-China trade, with global stocks and Treasury yields picking up last week on signs of progress.

Less clear in both the Brexit case and with U.S.-China trade is whether the market is doing a good job of pricing the longer-term risks. After 3 1/2 grueling years of talks, Britain will now enter even tougher negotiations about a trade deal with the EU. Meanwhile, the U.S. demands that China is most concerned about have been left for future rounds of talks.

Before getting to the long run, in the near term either or both deals could still fall apart.

Start with Brexit. The deal has already been rejected by Mr. Johnson's Northern Irish allies, who object to the region being left with a closer trading relationship to the EU than to the U.K. Mr. Johnson has no majority in Parliament so could easily lose the planned vote on the deal on Saturday. This might explain why the pound is still below this year's high of EUR1.18 reached during former Prime Minister Theresa May's repeated efforts to pass her Brexit deal through Parliament.

From the point of view of investors, this doesn't really matter. If Mr. Johnson's deal doesn't pass, parliament is likely to enforce its demand for extra time instead, and maybe even call a referendum on the deal.

Politically it would be hard for Mr. Johnson to insist on leaving without a deal just because Parliament rejected his deal, rather than put it to the voters in an election. And it would be extraordinary indeed if European governments backed the suggestion from Jean-Claude Juncker, outgoing European Commission president, that there can be no extension, as that would in effect mean the EU was ejecting the U.K.

A "no deal" Brexit that would trash the pound is far less likely than it was.

The situation is quite different with China. The U.S. demand for $50 billion or so a year of agricultural purchases is tricky for China. The pattern of coming close to a deal only for it to crumble at the last minute is well established. And when the difficult talks begin over the U.S.'s demands for deep changes in China's approach to subsidies, state intervention and technology transfers there is likely to be little sign that an acceptable compromise is any closer.

If the deals go through, it doesn't help that much. Companies are likely to continue to put off U.K. spending decisions where they can until the terms of trading with Europe are clear. That could take years and involve the politically contentious extension of the transition. Little has been solved.

In the U.S. even less will be resolved, even if the later rounds of the trade talks also work out. A trade deal with China will be fragile without the independent enforcement of a body like the World Trade Organization; the chance that Mr. Trump or his successors fall out with China again looks high, especially with bipartisan concern about the threat China poses.

To make matters worse, Mr. Trump's anti-EU rhetoric suggests he might pivot from his trade battles with China to a trade fight with Europe, which would be at least as damaging for investors as the trade war with China, and perhaps worse given the fragile state of the region's economies.

Still, markets climb a wall of worry. There's still plenty for investors to worry about in the manufacturing slowdown, trade, the prospects for politicians jacking up taxes and the lack of room for significant interest-rate cuts if and when the economy turns down. The worst time to buy is when everything looks good, and the most one can say today is that the outlook is marginally improved.

Write to James Mackintosh at James.Mackintosh@wsj.com

 

(END) Dow Jones Newswires

October 17, 2019 15:43 ET (19:43 GMT)

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