Pounds decline signals rising concern according to RSM Brexit Stress Index

The RSM Brexit Stress Index rose sharply in the week, signalling a rising concern in the market following depreciation of the British pound.  

The 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).

Brexit stress index

Simon Hart, lead Brexit partner at RSM, comments: ‘Our Stress Index is indicating some clear market anxiety in sterling depreciation. Pound and FTSE volatility is about twice as high as three to four weeks ago. In short this will result in higher costs for food, fuel and other consumer staples for UK households in the coming days and weeks. Add the events playing out outside of the UK, particularly the currency manipulation of the Chinese Yuan and the possible depreciation of the US dollar and the wider impact that will have, you would be wise to expect our index stress levels continue to move upwards over the coming weeks. If sterling continues to fall against the Dollar and Euro, UK business leaders should not only watch what the Government’s plans are for the expected expansionary fiscal policy, but also consider how to offset these global emerging economic challenges. It might just be about to get a whole lot harder out there.’

Pound collapses

The pound dropped in the week amid market volatility in London and Washington DC, while the FTSE 100 ended lower on higher volatility, as equity investors addressed the damage to earnings that might result from a global slowdown.

Perhaps of most concern in terms of future growth was the yield on 10-year gilts, which fell to 0.55%. The UK bond market is following the lead of German bonds, which have already dropped into the negative range of Japanese government bonds, the poster children for moribund economies (see below).

Brexit stress index

The low level of UK bond yields is an affirmation of the loss of business confidence and the downward drift of manufacturing activity as Brexit and US 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. 

‘The 3 month year on year indicators show that UK manufacturing output and sentiment levels are on a downward trajectory’, according to Hart

Brexit stress index

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 UK corporate bond spread.

The pound plummeted during the week, losing -1.9 per cent of its value versus the euro and 1.5 per cent against a basket of its trading partners. The pound has lost value for 13 weeks in a row and 22 per cent 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, but then gave back nearly all of its gains in the following days before plummeting on Friday. It ended the week down 1.9 per cent from a week ago.

The yield on 10-year gilts dropped 14 basis points in the week, falling back below 0.60 per cent 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 UK and globally.

Corporate spreads widened slightly for the first time in two months, signalling perceptions of increased risks presented by Brexit and resumption of US threats to global trade and growth. 

The RSM Stress Index tracks six variables:

1. British pound/euro exchange rate
An exchange rate measures expectations of relative interest rates and the demand for one currency relative to another due to trade and current account flows.

2. Volatility of the British pound/euro exchange rate
Low volatility suggests a stable environment in which to make investment or trade decisions. A spike to high volatility indicates uncertainty in the market.

3. Equity market performance
In the absence of shocks, stock indices show a tendency to grow over the years. We look at the weekly level of the FTSE 100 Index relative to the same week of the previous year.  

4. Equity market volatility
Spikes in the volatility of the FTSE 100 suggest the potential of a shock and an environment of uncertainty. 

5. Yield curve spread
A steep yield curve indicates the market expects sustained, long-term growth. A flat yield curve indicates the market is expecting low levels of growth.

6. Corporate yield spread
The corporate yield spread measures the risk of holding a corporate security versus the safety of a risk-free government security. The higher the spread, the more the perceived risk of economic distress and the prospect of corporate defaults.