Stress in the British financial markets has remained subdued over the four weeks since the general election. The RSM Brexit Stress Index, which measures financial and economic risk surrounding Britain’s impending departure from the European Union, started the new year at an insignificant 0.03 standard deviations above normal levels of implied stress, just slightly higher than last week’s 0.02 standard deviations below normal levels of stress.
While the calmness in the markets could be construed as a vote of confidence in the Brexit process, it might also be the result of diminished trading over a stretched-out holiday break. Since the Dec. 12 election, the pound is down more than 2% versus the euro and 1.7% against a basket of trading-partner currencies. And while the stock market is up 3%, the yield on 10-year gilts drifted lower in the period since the election, with an inverted yield curve signaling concerns over economic growth.
The markets are likely to react to each new conjecture over British and European Union policy decisions in the runup to the Jan. 31 start of the formal exit from the common market, with the foreign exchange market showing the most immediate response. And now there is the increased threat of geopolitical instability to factor into the price of financial assets. After all is said and done, the markets will need to consider the potential for disruptions to economic growth as trade policies and diplomacy are hammered out, which is likely to add to market stress.
Performance of index components
The RSM Brexit Stress Index is made up of six components; they include the 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 up the week increasing 0.1% versus the euro and 0.4% against a basket of its trading-partners’ currencies on lower volatility. British consumers must still contend with a double-digit pound deficit since the Brexit referendum, while speculative positioning continues to short the pound.
The FTSE 100 ended the week down 0.3% on higher volatility. This week’s negative return was the first loss since the general election, with only a last-minute positive reaction to an increase in oil prices mollifying the loss.
The bond market spent the second half of the week pushing the yield on 10-year gilts lower for the week to 0.75%. The government yield curve remains inverted, signaling concern for long-term growth. The corporate market continues to price in less risk, as it has for most of the past two months.