Destress continues in UK financial markets

Stress in the UK financial markets continues to moderate on the eve of Brexit. The RSM Brexit Stress Index, which measures financial and economic risk surrounding the UK’s impending departure from the EU, begins the week at just 0.23 standard deviations below normal levels of implied stress, while suggesting a more accommodative financial environment for borrowing and lending than before the December general election.

Brexit stress index 28/01/2020

Simon Hart, lead Brexit partner at RSM, comments:

‘The current index reading is the lowest it’s been since late 2017. Good news, in the short term at least. However, a marked reaction is likely to follow shortly after the UK’s formal exit from the EU as policy negotiations ramp up in the early stages of the one-year transition period. The markets will need to consider the potential for disruptions to economic growth as trade policies and diplomacy are negotiated, which is likely to add to market stress. This week’s BoE rate announcement may also have a say in how the markets react over the coming week.’

In terms of monetary policy, the Bank of England’s monthly GDP indicates no reprieve from the downward trend in either the service or manufacturing sectors, and the money markets are implying increased probability of an interest-rate cut as the year progresses. That suggests that Brexit will continue to be a drag on economic growth that will have a negative effect on the financial markets.

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 lost 0.5 per cent versus the euro over the last week, but gained 0.1 against a basket of its trading-partners’ currencies on lower volatility. UK consumers have been contending 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 0.1 per cent on lower volatility. 

The yield on 10-year gilts has been drifting lower for the past three days, reaching 0.75 per cent - about 10 basis points lower than yields at the end of the year when optimism for the economy growth was higher. The government yield curve remains inverted, which signals concern for long-term growth. The corporate market continues to price in less risk, as it has for most of the past two months.