RSM’s proprietary Brexit Stress Index showed that the heightened strain in the UK economy as a result of a possible hard Brexit has fallen.
The RSM Brexit Stress Index – which tracks the impact of Brexit on trade, wealth, the business cycle and corporate profits, on a week by week basis – dropped from a high of 0.77 on 8 March to 0.41 at close of markets on 5 April.
Cross party talks started last week and whilst the Labour party released a statement late on Friday saying talks had stalled, the RSM Brexit Stress Index nevertheless eased somewhat on expectations that the UK government may be moving towards a soft Brexit compromise Theresa May is seeking an extension to June 30. The EU will consider the request at this week’s EU Summit, but prior indications suggest an extension is likely, with Donald Tusk even suggesting a longer ‘Flextension’ of up to a year.
The FTSE 100 Index closed at 7447.87, up 0.61 per cent. Corporate spreads and government spreads also narrowed, which bolstered confidence in the markets.
To put this into wider context, the index has declined from over 2 points above neutral in December 2018, mostly due to financial markets pricing in a reduced probably of a hard exit from the EU.
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.