Stress in the British financial markets eased during the week, as domestic political events took a back seat to global market pressure. The RSM Brexit Stress Index, which measures financial and economic risk surrounding Britain’s impending departure from the European Union, closed the week lower, at 0.67 standard deviations above normal levels of implied risk, down 0.14 from last week’s close at 0.81 standard deviations.
The Bank of England held its base rate steady, most likely as a hedge against longstanding Brexit uncertainties and the possibility of further disruptions to both the British and global economy. Indeed, news on trade negotiations between the United States and China sent interest rates higher across the global bond markets. This was also the case in England, where low levels of business investment and slow growth might argue for decreased levels of future demand and lower interest rates.
With outcomes for both the trade war and the broader relationship between England and the European Union up in the air — and with the British election campaign chugging along — there is an indeterminate amount of time for some degree of financial and economic uncertainty to 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 British corporate bond spread.
The optimistic trade news raised the possibility that stronger growth in the American economy would lead to higher interest rates in the United States. That, in turn, would lead to a stronger dollar at the expense of the euro — and, to a lesser degree, a weaker pound. So the pound ended the week gaining 0.1% of its value versus the euro on lower volatility, while it lost 0.4% 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. The pound’s weakness is likely to contribute to the strain on domestic corporate profitability and household balance sheets that could be a factor in the public’s spending and political decisions.
The FTSE 100 stumbled over this week’s finishing line, ending 0.8% lower than last week’s close. Though volatility was slightly lower over the course of the week, we would expect volatility to remain higher than normal until the Brexit details are reasonably sorted out.
The bond market remains wary of the potential for British economic growth and remains inverted out to five-years’ maturity. Yields across the maturity spectrum moved higher on optimistic trade-war news, with the yield on 10-year gilts moving as high as 0.83% before closing the week at 0.79%. The corporate bond market priced in a slightly lower level of risk.