The RSM Brexit Stress Index moved up again this week, showing significantly higher levels of stress after the United States escalated its trade war with China and the Chinese renminbi was devalued against the U.S. dollar, causing upheaval in the global markets.
The composite index, which measures economic stress surrounding Britain’s impending departure from the European Union, closed at 1.69 on Friday from 1.24 a week earlier.
Currency and equity markets collapsed worldwide. Central banks in India, Thailand and New Zealand cut interest rates following a cut of 25 basis points by the Federal Reserve the prior week.
Despite the best intentions of policy moves espousing “Britain First” or “U.S.-First” motives, we live in an interconnected financial world that facilitates the investment necessary for economic growth. When financial markets move sharply in one country, worldwide repercussions follow.
The Bank of England can only wait so long for the “deal-no-deal” Brexit negotiations to be clarified amid the moves by other central banks and troubling domestic trends, including negative real UK GDP growth in the second quarter (and only 1.2% on a yearly basis), and a slowdown in U.K. manufacturing.
The details of Britain’s impending withdrawal from the EU trading bloc remain opaque, if not incomprehensible. Consumers worry about post-Brexit price hikes, the availability of medicines and whether their neighborhood restaurants will be able to serve up exotic offerings created from imported agricultural products if supplies are diminished.
It’s not surprising that recent Brexit polling suggests a change of heart; even Welsh citizens, once in favor of exiting the EU, have reversed their position, and the Scots are reconsidering their stance toward independence.
Looking forward, the European Union has extended Britain’s deadline to depart from the bloc to Oct. 31, leaving several more months of uncertainty.
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 was hammered during week, displaying a pattern of higher highs and higher lows as it lost nearly -1.7% of its value versus the euro on higher volatility. Yet the pound lost only -0.2% against a basket of its trading partners as the FX market was stunned by the action of the renminbi versus the U.S. dollar. The pound has lost value for 14 weeks in a row, off more than 22% percent versus the euro since April of 2015, when Conservatives formed a government on a promise to leave the common market.
The FTSE 100 was down as much as 3.4% at mid-week before recovering along with the global markets. UK stocks ended the week 2.2% lower than last week’s close on higher volatility.
The yield on 10-year gilts fell below 0.5%, dropping 6 basis points as investors looked for safety away from the equity market volatility. The yield curve is now inverted by 28 basis points out to 10-years maturity, perhaps setting the stage for a recession in the months to come.
Corporate spreads widened by 3 basis points, signaling perceptions of the increased risks of default should Brexit or U.S. trade policies threaten global trade and growth.
