The RSM Brexit Stress Index moved up again this week, showing marked levels of increased stress after the United States escalated its trade war with China and the Chinese yuan was devalued against the U.S. dollar, causing volatility in the global markets.
The index, which measures economic stress surrounding Britain’s impending departure from the European Union, closed at 1.69 on Friday from 1.24 a week earlier, and 0.71 the week prior to that.
Last week currency and equity markets lost significant value worldwide. Central banks in India, Thailand and New Zealand cut interest rates following a cut of 25 basis points by the Federal Reserve the prior week.
Simon Hart, lead Brexit partner at RSM, comments: ‘Our Stress Index continues to reflect continued and, in most cases, increased market anxiety as a result of sterling depreciation and wider market volatility. Following last week’s ONS report of the UK’s most significant drop in GDP since 2012, we will expect to see further increases in stress over the coming week and potentially beyond. Middle market businesses should keep a close eye on the index to monitor this trend so as to be best placed to stress-test and enact scenario planning. Lets not forget we’re only 11 weeks away from deadline day.’
Despite the best intentions of policy moves espousing 'Britain First' or 'U.S.-First' motives, we live in an interconnected financial world that facilitates the investment necessary for economic growth. When financial markets move sharply in one country, wider shifts in market performance follow.
The Bank of England can only wait so long for the Brexit negotiations to be clarified amid the moves by other central banks and domestic trends, including negative real UK GDP growth in the second quarter (and only 1.2 per cent on a yearly basis), and a slowdown in U.K. manufacturing.
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 U.K. corporate bond spread.
The pound depreciated during the week, displaying a pattern of higher highs and higher lows as it lost nearly -1.7 per cent of its value versus the euro on higher volatility. Yet the pound lost only -0.2 per cent against a basket of its trading partners as the FX market was stunned by the action of the renminbi versus the U.S. dollar. The pound has lost value for 14 weeks in a row, off more than 22 per cent versus the euro since April of 2015, when Conservatives formed a government on a promise to leave the common market.
The FTSE 100 was down as much as 3.4 per cent at mid-week before recovering along with the global markets. UK stocks ended the week 2.2 per cent lower than last week’s close on higher volatility.
The yield on 10-year gilts fell below 0.5 per cent, dropping 6 basis points as investors looked for safety away from the equity market volatility. The yield curve is now inverted by 28 basis points out to 10-years maturity, perhaps setting the stage for a recession in the months to come.
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 t