Stress in the UK financial markets saw a major dip as last night’s exit poll revealed an impending landslide election victory to the Conservative party.
The RSM Brexit Stress Index, which measures financial and economic risk surrounding Britain’s impending departure from the European Union, dropped to an insignificant 0.01 standard deviations above normal stress levels, down from last week’s already low reading of 0.29.
The Conservatives will form the next government with a clear majority, which implies a 31 January 2020 exit from the EU.
‘Boris Johnson has been presented with an overwhelming endorsement from the UK electorate to deliver the Conservative party manifesto following the 12 December 2019 General Election result. On one hand this presents increased certainty for businesses up and down the UK. On the other, businesses should be under no illusions that negotiations with the EU over the coming 12 months will be straightforward. The chance of an extension to the transition period beyond 31 December 2020 is a possibility, as is the chance of a ‘no-agreement’ exit at the end of 2020.’
The pound, which had been somewhat unresponsive in the runup to the election, strengthened dramatically in the overnight markets once it became apparent that Boris Johnson had been given a mandate. The pound then had to hang onto its gains as the day progressed.
The equity market gave its nod of approval, strengthening after the Friday morning opening and then holding its gains. And in the bond market, 10-year yields jumped as high as 0.89 per cent early in the day before settling at 0.85 per cent.
There is still an indeterminate amount of economic and policy uncertainty for the markets to reconsider. Just not today.
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’s immediate response to the election was a dramatic 2.6 per cent gain on the euro. The pound ended the week increasing 0.8 per cent on lower volatility versus the euro while losing 0.4 against a basket of its trading-partners’ currencies. UK consumers must still contend with a 11 per cent pound deficit since the Brexit referendum, while speculative positioning continues to short the pound.
The stock market response to the Conservative victory was for the FTSE 100 to pop up 1.5 per cent after the opening. For the week, the FTSE 100 turned in a 2.3 per cent return on higher volatility.
The bond market continues to price in stronger growth, pushing the yield on 10-year gilts higher by seven basis points for the week to 0.85 per cent. Still, the government yield curve remains inverted, but now only out to five-years maturity. The corporate market has been pricing in slightly less risk for most of the past two months.