The RSM Brexit Stress Index eased slightly during the week, as Britain’s Supreme Court ordered the resumption of Parliament and restored some sort of order to the Brexit chaos.
The composite index, which measures financial-market stress surrounding Britain’s impending departure from the European Union, closed the week at 1.20 standard deviations above normal levels of stress, down from last week’s close at 1.27. While stress remains high, it has retreated from the extreme levels of earlier this month when a constitutional crisis and a clumsy exit appeared inevitable.
The Supreme Court’s ruling was clearly welcomed by Britain’s markets and by the rest of Europe. After all, it’s in the best interest of the European Union to have the world’s fifth-largest economy within its barrier-free commercial zone, and it’s everyone’s second-best choice not to allow Brexit to upend the region’s supply chains. So what’s next?
The current political picture
This is what is known:
The Benn Act, passed on Sept. 9, requires the prime minister to request an extension for the withdrawal period no later than Oct. 19 should there not be a withdrawal agreement before then. But even then, there are loopholes yet to be closed.
Prime Minister Boris Johnson is scheduled to meet with European Union leaders on Oct. 17, but the latest reports suggest there is little chance that the withdrawal agreement crafted by former Prime Minister Theresa May will be renegotiated.
Here’s what can be assumed:
Johnson — having lost his majority — will pursue Brexit no matter what, if only to prevent losing votes to Nigel Farage’s Brexit Party.
The Labour Party will not agree to a general election unless a hard exit is no longer an option; this will prevent Johnson from making a backdoor crash out of the European Union.
Labour’s leader, Jeremy Corbyn, is not pro-Europe, and the Labour Party has avoided taking a position on Brexit, though it’s not unreasonable to guess that the majority of Labour supporters are Remainers.
The Liberal Democrats are outright opposed to Brexit. Led by Jo Swinson, they appear to offer a middle ground — somewhere between Corbyn’s policy excesses and Johnson’s personal excesses — that voters and the markets might find acceptable.
The financial markets are not Corbyn fans by any stretch of the imagination, considering his policies to be antithetical to its capitalist framework. Nevertheless, it would be tough for anyone to defend the markets’ performance since Conservatives won the 2015 general election on the promise to extract England from the European Union. The British pound has lost 15% of its value against a basket of its trading partners, Britain’s equity market has returned a meager 1.5% average annually, and the yield curve has inverted in anticipation of slowing growth in coming quarters.
Recent political events suggest an indeterminate amount of time for financial and economic uncertainty to continue. This would argue for higher volatility and risk being priced into financial assets, and the prospect of further loss of potential output and profit.
Performance of index components
The RSM Brexit Stress Index is made up of six components; they include the British pound-euro exchange rate and its volatility, the FTSE 100 and its volatility, the gilt yield spread and the U.K. corporate bond spread.
After appreciating for six weeks in a row, the pound lost 0.7% of its value versus the euro — on lower volatility — and lost 0.9% against a basket of its trading partners. The pound’s 15% loss in value since the Conservatives formed the government is likely to have a negative impact on household consumption and overall economic growth.
The FTSE 100 closed the week 1.0% higher on a reduction in volatility, with the market predicting that a decrease in the pound adds to corporate foreign earnings.
The bond market remains more direct in its assessment of the threats to economic stability and growth. The yield on 10-year gilts steadily declined over the course of the week, losing 13 basis points and ending the week below 0.5% again. The corporate market confirmed the potential disruption to growth and priced in a slight increase in risk. The 10-year/three-month yield curve is now inverted by 27 basis points, signaling the potential slowdown in growth.