The RSM Brexit Stress Index held relatively steady this week, maintaining high levels of stress as Germany’s manufacturing recession came front and center for the foreign exchange market.
The composite index, which measures economic stress surrounding Britain’s impending departure from the European Union, closed at 1.64 on Friday from 1.69 a week earlier, still significantly above normal levels.
Because an exchange rate is a two-sided asset, its value at any one time can be determined by perceptions of economic growth in either of two countries independently or relative to each other.
A week ago, all eyes were on the negative quarterly growth in the U.K,. and the pound suffered. And although U.K. and German manufacturing outputs are co-dependent and have been declining together throughout 2018-2019, this week’s market focus centered on German manufacturers’ plunging expectations, and subsequently, negative German real GDP growth in the second quarter—both working to pull the euro’s side of the coin down.
To prove that point, while the pound managed to gain on the euro, Britain’s equity market had lost nearly 3% at one point during the week and the yield on 10-year gilts dropped by nearly 10 basis points—not-so-subtle signals of expectation surrounding the U.K.’s departure from the European Union and future asset-market returns.
Looking forward, the European Union has extended Britain’s deadline to depart from the bloc to Oct. 31, leaving several more months of uncertainty. The current state of political discourse seems most likely to be pound-negative, particularly if the U.K. economy were to show signs of stumbling.
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 pound recovered from last week’s pummeling, regaining about 2% of its value versus the euro and 0.9% against a basket of its trading partners, all on a slight reduction in volatility.
The FTSE 100 continued its losing streak, dropping by 1.9% by the end of the week on higher volatility.
The yield on 10-year gilts reached as low as 0.40% during the week, but ended at 0.47%, only 2 basis points lower than last week’s close. The 10-year/three-month yield curve remains inverted by 30 basis points on concerns over the direction of U.K. and global growth.
Corporate spreads widened by six basis points on perceptions of an increased risk of business failures should Brexit or U.S. trade policies threaten global trade and growth.