Stress in the UK’s financial markets eased last week, as purdah kicked in, ensuring Westminster took a back seat to global market speculation of a US-China trade deal.
The RSM Brexit Stress Index, which measures financial and economic risk surrounding Britain’s impending departure from the EU, closed the week lower, at 0.67 standard deviations above normal stress levels, down 0.14 from the previous week’s close at 0.81.
Simon Hart, lead Brexit partner at RSM comments: ‘Despite an untidy start to the main political party election campaigns, the markets will remain more concerned over the bigger global picture beyond the domestic agenda. That will change of course the closer we get to 12 December. Indeed, news on trade negotiations between the United States and China sent interest rates higher across the global bond markets. With outcomes for both the trade war and the broader relationship between the UK and the EU uncertain there is an indeterminate amount of time for some degree of financial and economic uncertainty to continue.’
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 British corporate bond spread.
The optimistic trade news raised the possibility that stronger growth in the American economy would lead to higher interest rates in the US. That, in turn, would lead to a stronger dollar at the expense of the euro — and, to a lesser degree, a weaker pound.
So, the pound ended the week gaining 0.1 per cent of its value versus the euro on lower volatility, while it lost 0.4 per cent of its value against a basket of its trading partners. The pound still has a long way to go to recover its double-digit loss in value since the April 2015 onset of Brexit fever. The pound’s weakness is likely to contribute to the strain on domestic corporate profitability and household balance sheets that could be a factor in the public’s spending and political decisions.
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.