Stress in the British financial markets has been easing in the three weeks since the election announcement, continuing a holding pattern of sorts until there is more clarity on the political and economic fronts.
The RSM Brexit Stress Index, which measures financial and economic risk surrounding Britain’s impending departure from the European Union, closed the week at 0.42 standard deviations above normal levels of implied stress, down a bit from last week’s close of 0.48 standard deviations.
But even Though stress in the financial markets has subsided, it has not yet disappeared in the weeks since Brexit preparations took a back seat to the campaign and the U.S.-China trade negotiations cooled off again. Both the Bank of England and the Federal Reserve appear to be comfortable with holding interest rates steady for now, perhaps waiting for the political dilemmas to be resolved and for more clarity in the direction of each country’s economy.
The Bank of England is watching an economy that might have peaked at the end of 2018 — even as the labor market tightens and rising wages continue to buoy household spending. That spending could be in jeopardy, though, if the effects of a declining production sector since April and the prospect of Brexit-induced disruptions to trade were to add to the downward trend in employment opportunities.
The British economy may have peaked late in 2018…
And employment growth is slowing…
Still, wages have continued to rise…
Current polling suggests a fragmented opposition to Brexit, implying a Jan. 31 exit from the European Union common market. With outcomes for the U.S. trade war and British-European Union trade relationship still in doubt, financial and economic uncertainty will only continue.
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 three weeks of gains, the pound lost 0.3% of its value versus the euro on lower volatility during the week. Most of that loss occurred on Friday, on speculation that the euro area would strengthen more than the U.S. economy. The pound did manage to gain 0.1% of its value against a basket of its trading partners. The pound still has a long way to go to recover its double-digit loss in value since the April 2015 onset of Brexit fever, which is likely to contribute to strain domestic corporate profitability and household balance sheets that could be a factor in the public’s spending and political decisions.
The FTSE 100 ended the week on a stronger note, up 0.3% from last week’s close. Equity-market volatility bumped up relative to last week, but remains lower than normal. Nevertheless, because of global uncertainty and the perceived relationship of the equity market to currency movements, periods of higher volatility could be expected.
The bond market is wary of the potential for British economic growth and remains inverted out to 10 years’ maturity. The yield on 10-year gilts moved as high as 0.78% this week before closing Friday at 0.70%. The corporate bond market priced in a slightly higher level of risk.