The RSM Brexit Stress Index closed at 0.42 on Friday, moderating from 0.60 at the end of last week, as Prime Minister Theresa May officially exits her post at Tory leader.
The composite index—which measures economic uncertainty surrounding Britain’s pending departure from the European Union—remains within a range of normality in terms of asset-price performance and volatility. However, the fixed-income and currency markets are signaling an increase in stress, and therefore the potential for a less-accommodative climate for investment and economic growth in the months ahead.
As Theresa May departs, the financial markets appear to be wrestling with the implications of Britain walking away from negotiations with the EU if it can’t secure a favorable Brexit deal, a move considered by Boris Johnson, a leading contender for the PM post. Half of Britain’s exports are sent to its common market neighbors, and more than half of all imports are from the EU (figures 2 and 3 below). Not only are there obvious risks to the UK manufacturing base and the retail sector, there is also the most important risk of the UK losing its position as a destination for global investment.
The EU has extended Britain’s deadline to depart from the bloc to Oct. 31, which leaves months of uncertainty ahead as the UK political shake-up continues and as the EU’s response becomes clearer. Johnson, the Conservative Party favorite, this week won a UK court ruling that stifles a move to prosecute him for misconduct related to claims he made in 2016 about Britain’s payments to the EU; the claims were later discredited. The ruling helps Johnson move ahead with his bid to become prime minister. Bloomberg reported Friday that Johnson’s chances of becoming PM have risen to 60 percent, up from 33 percent a week earlier.
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 UK corporate bond spread.
The pound lost another 0.5 percent of its value during the week against the euro and other major currencies for a cumulative loss of 4.4 percent since the May 2 local elections, with a drop in currency market volatility during the week.
The composite index—which measures economic uncertainty surrounding Britain’s pending departure from the European Union—remains within a range of normality in terms of asset-price performance and volatility. However, the fixed-income and currency markets are signaling an increase in stress, and therefore the potential for a less-accommodative climate for investment and economic growth in the months ahead.
With no place left to go, investors pushed the equity market higher. The FTSE 100 gained 2.4 percent this week with a drop in volatility, all but recouping losses since the May 2 elections.
The yield on 10-year gilts has dropped by 7 to 10 basis points for the past five weeks, for a total decline of 41 basis points since the local elections. Although the gilt spread remains within normal levels, the flattening of the yield curve to only 3 basis points suggests increasing concerns for future economic growth. Corporate spreads were only slightly higher than last week, continuing five weeks in a row of higher risk being priced into the market.
