Stress in the financial markets pushed a bit higher during a tumultuous week that included the European Union granting an extension of the Brexit deadline to Jan. 31 and Parliament granting Prime Minister Boris Johnson’s wish for a December general election.
The RSM Brexit Stress Index, which measures stress surrounding Britain’s impending departure from the European Union, rose slightly as the financial markets priced in a bit more volatility and risk to the enduring Brexit saga. The index closed at 0.83 standard deviations above normal levels, up from last week’s close at 0.71 standard deviations.
The markets seemed to assign equal weights to those two political developments. While the European Union’s extension offered some relief and allows more time to resolve the future relationship between Britain and its largest trading partner, the election brings a host of potential developments to the fore.
In response, the currency markets were a bit bullish on the pound, while the equity market drifted lower and the bond market maintained its anticipation of slower growth.
The election and prospect of flipping the switch on British trade agreements leave 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 pound ended another up-and-down week and regained only 0.1% of its value versus the euro on higher volatility, while gaining 0.4% against a basket of its trading partners. The pound’s double-digit loss in value since the April 2015 onset of Brexit fever is likely to contribute to the strain on household balance sheets, which could be a factor in the public’s spending and political decisions.
The FTSE 100 staggered lower over the course of the week, finishing 0.3% lower than last week’s close. 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 economic growth in Britain. The yield on 10-year gilts moved as low as 0.61% before closing the week at 0.67%, while the yield curve remained inverted. The corporate bond market maintained its spread over gilts.