The RSM Brexit Stress Index moved higher this week on increased currency market volatility and sobering economic news from the U.K.’s trading partners as Boris Johnson, the pro-Brexit Conservative Party candidate, was elected prime minister.
The composite index, which measures economic stress surrounding Britain’s impending departure from the European Union, closed at 0.65 on Friday from 0.47 a week earlier (see Figure 1).
The increased volatility in the foreign exchange market came amid diminished expectations for Germany’s industrial sector, which had already fallen below a negative 3% yearly growth rate. Under the best of trading circumstances, that news would be distressing for U.K. manufacturers (see Figures 2-3).
While the index remains at above-average levels of stress, it is within a range of normality in terms of asset-price performance and volatility. Elevated levels of stress indicate a less-accommodative climate for investment and the potential for lower economic growth in the months ahead.
Looking forward, the European Union has extended Britain’s deadline to depart from the bloc to Oct. 31, which leaves months of uncertainty regarding the EU’s response to future U.K. government proposals for the terms of the exit. Johnson, the UK’s former foreign secretary, was elected earlier this week to succeed Theresa May as PM. Johnson has committed to completing Britain’s exit from the U.K. by the October deadline.
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 ended the week only slightly down, but remains 5% lower in value since the local elections in early May. Volatility moved higher over the week, as the foreign exchange market priced in its diminished outlook for German growth.
Equity markets among the U.K.’s trading partners staged a last minute rally on news that U.S. GDP growth stayed above 2% in the second quarter. The FTSE 1000 had traded higher earlier in the week during Johnson’s ascension, but ended only 0.5% higher by week’s end.
The yield on 10-year gilts dropped just below 0.70% and the yield curve inverted out to 10-years maturity on concerns over the direction of U.K. and global growth. The 10-year/three-month yield curve spread is now at negative 9 basis points, its lowest level during the run-up to Brexit (see Figure 4). Corporate spreads narrowed for the seventh week in a row, perhaps having already priced in the increased risk presented by Brexit.
