Stress in the UK financial markets continued to ease as the general election draws closer. The RSM Brexit Stress Index, which measures financial and economic risk surrounding Britain’s impending departure from the European Union, closed the week at 0.29 standard deviations above normal levels of implied stress. It marked the lowest level of risk in what seems like an eternity since former Prime Minister Theresa May stepped down and current PM Boris Johnson moved in.
The latest polling suggests a 43% to 32% Conservative lead over Labour, despite 53% of the public wanting Britain to remain in the EU. Although Brexit fatigue and disenchantment with Labour’s policy proposals might be contributing to that inconsistency, recent reports suggest overarching resentment among some cohorts, which might lead to a reshuffling of the two dominant political parties.
After all, the manufacturing base had the rug pulled out from under it at the start of the decade, and it’s not getting any better for at least some of the population. For instance, the downward trend in unemployment for men appears to have ended in late 2018, while the unemployment rate among women continues to move lower. The widening of the gap between employment opportunities for men and women is indicative of the upending of traditional norms and the resulting distaste for immigration and all that membership in the EU common market entails.
If Conservatives were to form the next government, this would imply a Jan. 31st exit from the EU. As that date approaches and as various trade relationships move beyond wishful thinking, an indeterminate amount of economic uncertainty will remain for the markets to reconsider.
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.
The currency markets seem most optimistic about the election, putting the pound on a tear and gaining 1.2% on the euro this week, and 0.8% the prior week. On a longer-term basis, the pound is now up 5% for the year against a basket of its trading partners, which puts a hefty dent in what would otherwise be a 15% deficit since the Brexit referendum. That degree of optimism, however, should probably be tempered by speculative positioning in the foreign exchange market, which continues to short the pound.
The conventional culprit for faltering UK share prices is a stronger pound, which eats into off-shore profits. Although the pound’s performance the past two weeks clearly fits the bill, some of the blame for the FTSE 100’s 1.5% loss this week is surely Brexit-related, with the markets hedging expectations for faltering economic data and the possibility of a worsening trade situation.
The bond market has taken the opposite course, pricing in stronger growth once the Brexit mess is over, pushing the yield on 10-year gilts higher by 7 basis points for the week to 0.77%. The government yield curve remains inverted — but now only out to 5-years maturity – and the corporate market has been pricing in slightly less risk for most of the past two months.