The RSM Brexit Stress Index moved higher again in the week, as Prime Minister Theresa May of the Conservative Party resigned her post following multiple failed attempts to solidify a plan for Britain’s departure from the European Union.
The index — which provides a composite measure of the political and economic uncertainty surrounding Brexit.– rose to 0.53 on Friday after pausing at 0.36 a week earlier. While the index remains within a range of normality in terms of asset-price performance and volatility, the markets are nevertheless signaling an increase in stress and the potential for a less accommodating climate for investment decision-making and economic growth in the months ahead.
“To succeed, he or she will have to find consensus in Parliament where I have not,” media reported May as saying following her resignation. In the aftermath of her decision, one of May’s top rivals, former Foreign Secretary Boris Johnson, proposed keeping the no-deal option on the table for Britain, adding uncertainty to the markets.
Economic downturns “are often associated with tighter financial conditions and an increase in uncertainty,” The Bank of England noted in its analysis of Brexit results.”In turn, these weigh on demand.” So to the extent that financial-market performance is based on expectations for growth, the performance of the currency, equity and bond markets since April reflects recognition of the negative effects of Brexit on the economy. Forecasts of the economic loss resulting from a soft or a hard Brexit range from 1.3 percent to 7.75 percent, or worse. And as the experience of past financial crises show, the detrimental impact of such losses can have long-term consequences for the workforce and future economic growth.
After an April lull — when the European Union extended Britain’s deadline to depart from the bloc to Oct. 31 — financial stress reappeared in May as the financial markets attempted to size up the political consequences stemming from local elections held at the beginning of the month, and the European Parliament election near the end. With the EU results not yet announced and with Britain’s prime minister about to step aside, there is bound to be more volatility ahead.
With the EU results not yet announced and with Britain’s prime minister about to step aside, there is bound to be more volatility ahead.
The RSM Brexit Stress Index is composed 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 UK corporate bond spread.
The pound lost roughly 0.5 percent of its value during the week against the euro and other major currencies for a cumulative loss of 3.6 percent since the May 2 local elections. There has also been a pickup in currency market volatility throughout the month, though volatility remains at below-average levels.
The equity market has now dropped in four of the past five weeks. After last week’s gain, the FTSE 100 lost 1.0 percent during the week and 1.4 percent since the local elections, with increases in volatility.
The yield on 10-year gilts dropped another 8 basis points in the past week, for a total decline of 26 basis points since the local elections. Although the gilt spread remains within normal levels, the recent flattening of the yield curve to only 16 basis points suggests increasing concern over future economic growth. Corporate spreads widened for the third week in a row, signaling heightened perceptions of pending risk.