Simon Hart, RSM's Brexit lead partner discusses RSM’s Brexit Stress Index which gives forward-looking investors, business executives and policymakers an instant snapshot of the economic impacts of Brexit.
‘The Brexit Stress Index tracks the weekly performance of six economic variables and combines them into a single measure which is assessed against a baseline 'normal' level of stress in the economy.
‘After a tumultuous week in politics, the index has risen almost 30 per cent in just one week - it increased to 0.71 points above neutral in the week ending 22 March, up from 0.55 in the previous week.
To put this into context, the index has declined from over two points above neutral in December 2018, mostly due to financial markets pricing in a reduced probably of a hard Brexit. However, the events of the last week could mark the start of a reversal of this trend.
Over the last week, volatility across the foreign exchange markets linked to declines in the value of the pound has pushed the index higher. The FTSE 100 also fell amid the political fallout from the European Council summit.
If the coming days produce political turmoil similar to last week, policymakers, middle-market business leaders and investors can expect stress in the financial markets to increase sharply, creating risks of a spillover into the real economy that would further depress productivity-enhancing investment in the UK. In those circumstances, the RSM Brexit Stress Index would increase in the week ahead.
'In addition, over recent weeks, we have seen more evidence of a slowdown in economic activity in the US and Germany which has raised the risks of a global recession over the next 12 months.
'This combination of stress related to the path of policy on Brexit and the increasing global headwinds faced by the British economy point towards difficult challenges ahead for UK economic policymakers. Whatever the outcome of the next few weeks of negotiations, the government will need to find ways of stimulating the domestic economy, driving up private fixed business investment and reducing business uncertainty.'
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.