The RSM Brexit Stress Index rose sharply in the week, signaling significant worry in the market following depreciation of the British pound that will result in higher costs for food, fuel and other consumer staples for U.K. residents.
The composite index, which measures economic stress surrounding Britain’s impending departure from the European Union, closed at 1.24 on Friday from a revised value of 0.71 a week earlier (see below).
[Note that the index has been revised, with the 30-day historical volatility of the FTSE 100 replacing the implied volatility measure that is no longer available.]
The pound dove in the week amid chaos from London and then Washington, D.C., while the FTSE 100 ended lower on higher volatility, as equity investors sorted out the damage to earnings that might result from a global slowdown.
Perhaps most distressing in terms of future growth was the yield on 10-year gilts, which fell to to 0.55%. The U.K. bond market is following the lead of German bunds, which have already dropped into the negative range of Japanese government bonds, the poster children for moribund economies (see below).
The low level of U.K. bond yields is an affirmation of the loss of business confidence and the downward drift of manufacturing activity as Brexit and U.S. policy decisions threaten further disruptions to global trade (see below), and the elevated level of stress in the financial markets suggests 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 UK government proposals for the terms of the exit.
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 plummeted during the week, losing -1.9% of its value versus the euro and 1.5% against a basket of its trading partners. The pound has lost value for 13 weeks in a row and 22% of its value versus the euro since April 2015, when Conservatives formed a government on a promise to leave the common market.
The FTSE 100 gained on Monday as the pound was hammered, but then gave back nearly all of its gains in the following days before plummeting on Friday. It ended the week down 1.9% from a week ago.
The yield on 10-year gilts dropped 14 basis points in the week, falling back below 0.60% for the first time since the Brexit referendum in June 2016. The yield curve inverted by 22 basis points out to 10-years maturity, indicating concerns over the direction of growth in the U.K. and globally.
Corporate spreads widened slightly for the first time in two months, signaling perceptions of increased risks presented by Brexit and resumption of U.S. threats to global trade and growth.