The market is in panic mode at the start of a fresh week after the latest poll ahead of the Scottish referendum put the yes campaign (who wants independence) in the lead for the first time since the campaign began. Not even the announcement that another Royal baby is on the way could bury this news.
After basically having it in the bag since the beginning, the no campaign has blown its comfortable lead; so should we blame an ineffectual Darling or a disinterested Westminster for the no campaign’s fate this close to the election?
We think this is being a bit unfair to the no campaign. As we mentioned in a NOTE from last week, the experience in Canada when Quebec held a referendum on sovereignty was fairly similar, the no campaign held a comfortable lead until the last few weeks when the yes campaign started to catch up.
In the end the no campaign only won a wafer thin majority, which we think could happen in this election. Interestingly, even after the no campaign won and Quebec remained part of Canada, capital and bank deposits seeped out of Quebec after the referendum as businesses and individuals did not want a repeat referendum down the line.
Although other polls have not put the yes campaign ahead of the no campaign, and while we believe that the no campaign will win on the 18th September, we are less certain of this after the poll results of the past week. When you mix politics with national pride, anything could happen.
But, looking on the upside, from an FX perspective, these are some of the biggest moves that we have seen in more than a year. GBP long positions are at their lowest level since January, according to the latest CFTC data, while GBP volatility has surged. 2-week volatility for EURGBP at-the-money options spiked to its highest level since early 2013, and is not that far off levels experienced during the Eurozone sovereign debt crisis.
The markets are prone to over-react, however, even if we believe that the no vote will come through in the end, the uncertainty and unknowns related to a break-up means that there is little chance for GBP upside until the after September 18th. We think the pound has more potential to lose value against the US dollar, as the BOE is likely to push back the prospect of rate hikes if the yes vote succeeds on the 18th.
In contrast, we think that the Federal Reserve will shrug off the weak August NFP figure, and announce their next steps towards tighter policy, potentially at their next meeting on 17th September. Hence, although the gloss was taken off the dollar at the end of last week, the post payrolls decline was short-lived.
Over the next 10 days, here are a few things worth noting:
GBPUSD:
We think that the pound could be in for a rough ride. The market’s insecurities and concerns for an independent Scotland means that the pound would be in the firing line if the yes campaign wins, however the pound could also be under pressure if the no vote win, but only by a small margin. A small failure for the yes campaign could 1, cause social unrest, 2, trigger expectations that another repeat referendum could be held down the line.
From a technical perspective, GBPUSD seems to be in no man’s land while we wait for this referendum. The break below major support at 1.6284 – the 38.2% Fib retracement of the July 2013 – July 2014 bull trend. The low so far on Monday has been 1.6103, however, the break below support opens the way to 1.6003 – the 50% retracement and then 1.5722 – the 61.8% retracement of the same move – as we lead up to next week’s vote.
UK stocks:
UK markets are leading the way lower today, and the financial sector is under particular pressure. UK stocks had not priced in the prospect of a yes vote, last week the FTSE 100 was close to a record high, so it is now playing catch up. Due to the uncertainties around an independent Scotland’s currency, debt liabilities and tax rates, the financial sector is taking the brunt of the hit.
UK lenders, including Lloyds Banking Group (LONDON:LLOY), who has the largest Scottish mortgage loan book in the UK, along with Scottish companies such as Royal Bank of Scotland Group (LONDON:RBS) and Standard Life (LONDON:SL), are also suffering.
However, after a short, sharp sell-off, a yes vote for independence may not be as toxic for the broader UK stock market as you think, especially if it delays a rate rise from the BOE. But Scottish based companies, particularly lenders like RBS, could suffer even if Scotland votes no.
As we mention above, even though Quebec voted to stay part of Canada there was still an element of nervousness in the market including deposit flight from local banks and companies relocating in case of a repeat referendum down the line.
European stocks:
European stocks are outperforming the UK market today, however if Scotland leaves the UK this could be the end of European Union. The Tories would be expected to win the 2015 election if Scotland leaves the UK, which would then mean a referendum on the UK’s EU membership would most likely take place in 2017.
If the UK votes to leave the EU, it is hard to see how it could continue without an effective counter balance to German dominance. Thus, European stocks may not be panicking right now, but they could be once we find out the outcome of the 18th September vote.
Takeaway:
- • The markets are in panic mode, and starting to contemplate the prospect of a win for the yes vote.
- • Even if the no campaign wins, we expect it to be by a very slim margin.
- • Based on what happened in Quebec in the 1990’S, even a win for the no campaign could have negative repercussions for some Scottish companies and may not be that good for sterling in the medium-term.
- • We think that the outlook for GBP, especially versus the USD, looks bleak over the next 10 days to the referendum.
- • In GBPUSD 1.5722 is key support leading up to 18th Sept.
- • UK stocks are also likely to remain under pressure in the lead up to polling day. The financial sector is particularly under pressure.
- • Even a win for the no campaign could hurt Scottish companies if it triggers capital and deposit flight. Thus, the FTSE 100 may have made a temporary top at 6,904.
Figure 1: 
Source: Please note that this is a Bloomberg Chart and does not represent the prices offered by FOREX.com
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