The RSM Brexit Stress Index surged this week, following news that the Prime Minister had been granted permission to suspend Parliament just weeks ahead of the deadline for the UK to withdraw from the European Union.
The composite index, which measures economic stress surrounding Britain’s impending departure from the EU, closed at 1.85 on Wednesday, up nearly 10 basis points from last Friday’s close at 1.76. Prime Minister Johnson’s ability to suspend Parliament ahead of Britain’s 31 October Brexit deadline signals the increasing likelihood that his Brexit strategy will proceed, as it gives Parliament less time to challenge, question or block his plan.
The index—which reflects significant stress in the bond market—has now reached levels associated with the 2016 Brexit referendum result date and the rejection of the Prime Minister Theresa May’s EU deal. Higher levels of financial market stress are associated with pullbacks in lending and borrowing practices and portend slower economic growth in coming quarters.
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.