The RSM Stress Index, a measure of Brexit-related economic volatility, inched up again this week after two consecutive weeks of flatlining and low stress. The index finished the week at 0.34 points above zero, marginally up from last week’s 0.02.
Although remaining within a range of normality in terms of asset price movement and volatility, financial market stress is nevertheless inching higher again as the European elections approach.
‘Until three weeks ago, the index indicated that stress had been declining since PM Theresa May survived a no-confidence vote in December. But as a May 23 election for UK members of the European Parliament approaches, and political affiliations look to become unglued, financial market stress is on the rise again. In addition we have yet to see the impact of the escalating US-China trade war and the wider economic implications for the UK. Personally, I would expect some increase in the stress index number in the weeks ahead.’
This week’s change in sentiment was particularly notable in the currency market, which appears to be pricing in the diminished probability of a Tory-Labour compromise, and the greater probability of a hard Brexit result.
The pound, which had been gaining since December 2018, lost 1.4 per cent of its value versus the euro in the last week, whilst still trading within a period of reduced volatility.
The RSM Brexit Stress Index tracks the weekly performance of six variables – the pound/euro exchange rate, the volatility of the pound/euro exchange rate, the performance of the equity market, the volatility of the equity market, the yield curve spread and the corporate yield spread.
These variables are combined into a single measure and assessed against a baseline 'normal' level of stress in the economy. The baseline zero score indicates neither an increase or decrease of stress in the system. The index is designed to give forward-looking investors, business executives and policymakers an instant snapshot of the economic impacts of Brexit.
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.