15 September 2014

Currency crunch looms over Scottish referendum

On the brink of Scotland voting ‘yes’ or ‘no’ for independence, financial markets have suddenly grown queasy.
​​​​​​In the last week, the uncertainty has seen GBP fall against the EUR and slide to 10-month lows against the USD. Meanwhile, the cost of hedging against sharp swings from a possible ‘Yes’ vote to end the union has soared significantly: GBP one-month implied volatility leapt to its highest since July 2013.

What this means for traders?

Traders are now left in a quandary. The cost of taking insurance against a ‘Yes’ vote has risen markedly; two-week GBP/USD implied volatility straddling the date of the vote has tripled to 12%. This means it could be an expensive option to take if the ‘No’ vote wins.

If the ‘No’ vote succeeds, GBP could enjoy a relief rally, which makes sterling’s current valuations attractive. That Mark Carney, governor of the Bank of England, has suggested UK interest rates could rise as soon as Spring 2015, could be interpreted as a bull signal for GBP.

However, traders preparing for this eventuality risk being exposed if the ‘Yes’ vote succeeds. In this scenario, even at current levels, hedging positions against a break-up of the union may appear to be the cheaper option.

Expectations for the week ahead

  • Risk of tumultuous market conditions this week, with GBP reacting to each new sentiment poll that is released.
  • Possibly more announcements from the big corporates. Royal Bank of Scotland and John Lewis threatened to move out of an independent Scotland and warned of rising prices, respectively. BlackRock, the world’s largest investment manager, recently said it was shorting sterling by buying various derivatives. Other fund managers have claimed investors are already withdrawing money from UK equity funds.
  • Any significant shift in favour of the ‘Yes’ vote could see GBP continue to depreciate.
  • Any relief rally of GBP in the event of a ‘No’ vote could be short-lived; next year’s general election and then a potential referendum on European Union membership may weigh on financial market participants.

Outcome of the final debate

Recent polls suggest Alex Salmond and his independence campaign have at least closed the gap on Alistair Darling and the Better Together campaign, following the most recent debate.

The ‘No’ campaign is still leading by 52% to 48%, according to the latest YouGov poll, but the ‘Yes’ campaign is maintaining its gains. That has led the country’s two biggest bookmakers, Ladbrokes and William Hill, are laying 7-to-4 odds against a ‘Yes’ vote.

The Scottish Referendum vote will be held on Thursday 18 September. The result could be announced overnight or in the morning of Friday 19 September.

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