One week into Brexit, the foreign exchange and fixed-income markets are showing signs of doubt and perhaps the beginning of a hedge on a bet that the government can quickly renegotiate its trade agreements with the world and that the British economy will be left better off.
The RSM Brexit Stress Index — which measures financial and economic risk surrounding Britain’s impending departure from the European Union — begins the next 11 months of trade negotiations at only 0.06 standard deviations below normal levels of implied stress.
After a month of reduced volatility, the foreign exchange market appears to be pricing in lower expectations for the pound again. And though 10-year yields bumped up five basis points in the past week, yield levels hovering just above 0.50% are distressingly low and England’s inverted yield curve suggests that the Brexit process will continue to be a drag on economic growth.
It can be argued that the markets like certainty, which explains the calm after the general election. Now that Brexit has truly begun, it is difficult to expect that low-volatility climate 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 lost 1.1% versus the euro over the past week, and 1.4% against a basket of its trading-partners’ currencies on higher volatility. That will only add to a double-digit pound deficit since the Brexit referendum, with negative implications for household balance sheets that could be a drag on consumer spending in the months ahead.
The FTSE 100 ended the week up 2.5% on higher volatility as the equity market responded to the pound’s impact on overseas profits and the U.S. market’s upsurge.
The yield on 10-year gilts range-traded during January before bouncing up to 0.57% by the end of this week. The government yield curve remains inverted, which signals concern for both short-term and long-term growth. The corporate market continues to price in less risk, as it has for most of the past three months.