An anti-Brexit demonstrator waves a Union flag, also known as a Union Jack, with an European Union (EU) flag outside the Houses of Parliament in London, U.K. (Photographer: Simon Dawson/Bloomberg)

So Bad It’s Good: Markets See Silver Lining in Brexit Rejection

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Prime Minister Theresa May’s record defeat in Parliament over her Brexit divorce deal provoked a curious response from markets: Optimism.

The pound drifted on Wednesday and gilts -- a traditional safe-haven investment -- sold off even though the margin of the Prime Minister’s loss was way above the threshold many analysts feared would trigger a panic. The prospect of a no-confidence vote in May later this evening has also failed to disrupt assets amid a general assumption she will prevail.

So Bad It’s Good: Markets See Silver Lining in Brexit Rejection

The one soft spot was the FTSE 100 Index of shares -- which tends to fall when the currency performs well.

The key to the robust showing from U.K. assets appears to be in the scale of May’s defeat. The deadlock in Parliament is clearer than ever, and a belief is growing among many financial professionals that there’s an increasing chance of a so-called soft-Brexit or even no Brexit at all. Those are outcomes many investors would cheer.

“The chances of a no-deal Brexit are so slim now it’s not even really worth considering anymore,” said Greg Gibbs, founder of Amplifying Global FX Capital. “It looks increasingly that the resolution will be an even softer version than May’s proposal and/or a new referendum.”

That’s a view shared by a host of analysts polled by Bloomberg, who talked up the pound’s prospects in the wake of the vote. Banks including Standard Chartered Plc and Credit Agricole SA are among those who expect May to survive the no-confidence vote called by the opposition.

Looking deeper into the underbelly of markets offers further evidence of a pickup in confidence among traders. The cost of insuring U.K. banks’ subordinated debt fell, while volatility on pound options has slumped.

So Bad It’s Good: Markets See Silver Lining in Brexit Rejection

Mayank Mishra, a global macro and FX currency strategist with Standard Chartered in Singapore, reckons the pound will be broadly supported as the market assigns a high chance the government will survive the confidence vote -- and a low prospect of a disorderly Brexit.

There’s another factor in the remarkable resilience of markets to the vote. A lot of bad news has already been priced into U.K. assets, so the bar for a nasty shock is high.

So Bad It’s Good: Markets See Silver Lining in Brexit Rejection

“Going into the vote there was a heavy consensus that the government would suffer an even heavier defeat,” said Christopher Jeffery at Legal & General Investment Management. Hence the “market reaction has been relatively muted,” he said.

Not everyone sees the glass as half full. One undeniable outcome of the defeat of May’s deal, regardless of the confidence vote later, is further delay to the Brexit process and yet more uncertainty for traders. Dean Turner of UBS Global Wealth Management is among those recommending caution.

“U.K. assets will continue to be vulnerable to the political volatility and we don’t expect this will subside until a concrete conclusion emerges,” the economist said. “We do not advocate investors take directional views on sterling, gilts or U.K. stocks while this clarity void remains so large.”

Fidelity International Leigh Himsworth is similarly wary. He’s reminding investors that a no-deal Brexit remains the default option, and that the mechanics of any other possibilities are difficult. He recommends investing in liquid assets and hedging against the various outcomes.

The pound was less than 0.1 percent lower at $1.2851 as of 2:05 p.m. in London. The FTSE 100 Index slipped 0.4 percent, and the yield on 10-year gilts rose seven basis points to 1.325 percent.

May lost the vote on approving her Brexit deal by 432 to 202.

“This outcome is so dire for Brexit that the chances of a softer Brexit or even a second referendum may have risen,” said Stephen Jen, chief executive of Eurizon SLJ Capital, who estimates the currency’s fair value is between $1.50 and $1.55. The pound is “so weak and so cheap -- it is so undervalued,” he said.

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