The RSM Brexit Stress Index moved higher last week, as the currency, equity and bond markets reacted to the political posturing around a hard exit from the EU and the impact of what looks to be a slowdown in global growth.
The composite index, which measures economic stress surrounding Britain’s impending departure from the European Union, closed at 0.47 on Friday from 0.26 a week earlier (see Figure 1). The index remains at slightly above-average levels of stress, but within a range of normality in terms of asset-price performance and volatility. Elevated levels of stress indicate a less accommodative climate for investment and the potential for lower economic growth in the months ahead.
Most of the increase in stress is tied to the bond market, which appears to be bracing for the end of the economic upcycle and the convergence of global growth at subdued levels. The yield on 10-year gilts dropped by 10 basis points during the week as it digested signs of possible softening in the labour market. That left the yield curve barely positive, anticipating a response by the monetary authorities no matter what the Brexit outcome may be.
Following on from the election of Boris Johnson as Conservative Party leader this week, we wait to see how the markets and the RSM Brexit Stress Index changes over the next few weeks as the ‘politics of Brexit’ under Prime Minister Johnson manifests itself and as the EU's response to the government's new proposals becomes clearer.
Performance of index components
The RSM Brexit Stress Index is made up of six components; they include the 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 currency markets spent the week reacting to the hardening of Brexit positions in the final Conservative leadership debate and then the prospect of a 50 basis-point cut to the U.S. Federal Funds rate, which drove the dollar down against the major currencies. The pound managed a rebound on hopes of some sort of Brexit reconciliation, but this was the eleventh week in a row that the pound has lost ground against the euro and its major trading partners.
The FTSE’s early-in-the-week gains were erased as investors balanced a slowdown in global growth with the prospect of lower interest rates leading to future equity market gains.
The yield on 10-year gilts lost 10 basis points on expectations of an eventual monetary response to slower growth. The U.K. yield curve remains inverted out to 10-year maturities.