Will a Brexit deal unleash the FTSE 100?

The FTSE 100 has underperformed other major indices this year, but could a last-minute Brexit deal allow it to catch up?

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How has the FTSE 100 performed in 2020?

It has been a turbulent year for global markets thanks to the coronavirus pandemic and, whilst we are some way from getting back to normal, many have already managed to recoup their losses. The S&P 500, DJIA, and the MCSI World Index all hit new record highs on December 17.

The DAX has also recovered all its pandemic-induced losses to hit new highs and is now up 1.5% since the start of the year, outperforming the wider region considering the Euro STOXX 50 index is down 6.5%.

Meanwhile, the FTSE 100 has failed to stage such a recovery and is still down 15% year-to-date. The main reason it has underperformed is because it has been plagued by Brexit uncertainty, and the risks associated with Brexit are considered greater for the UK than the EU.

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How could a Brexit deal impact the FTSE 100?

A last-minute Brexit deal would help remove the biggest cloud of doubt that has lingered over UK equities for the last four years. The immediate reaction to any deal being announced would therefore be positive for the index and allow it to start recovering at a quicker rate.

However, the index is likely to remain volatile as everyone dives into the text of what is likely to be a hefty document. For markets, any deal is better than a no-deal, but the devil will be in the detail.

Any deal would aim to minimise disruption, but it wouldn’t mean everything would continue as normal and many businesses would still have to adapt to changes introduced overnight on January 1. For example, the services industry – which accounts for 80% of UK employment – is not expected to be covered by a last-minute deal.

Plus, there is the role of the pound to consider. Sterling has proven more sensitive to Brexit talks, strengthening on hopes of a deal and weakening when one looks unlikely. The FTSE 100 prefers a weaker pound considering over 70% of their revenues are made abroad, allowing them to benefit when they convert their overseas earnings into softer sterling.

Therefore, a stronger pound in the event of a deal could limit the FTSE 100, but it is unlikely to prevent the FTSE 100 heading higher over the longer-term in the event of a deal as appetite for UK equities increases. Today, with a deal expected imminently, the FTSE 100 is broadly flat in early trade while the pound has rallied 0.5% against the euro and 0.6% against the dollar.

Uncertainty is why the FTSE 100 has lagged other indices this year, but a last-minute deal would start to bring the clarity needed to reinstall confidence and allow the FTSE 100 to catch up.

However, Brexit is not the only headwind to the FTSE 100 and other indices. The coronavirus pandemic is far from over and the focus next year will switch to the speed at which countries can vaccinate their citizens and get their economies back up and running.

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