Scotland: is the market too eager to price in a No victory?

The pound has climbed to a 2 week high and with only a few hours of voting for the Scottish referendum left the market seems happy to price in a victory for the No camp. We should find out in the early hours whether or not the market is right to be so optimistic at this early stage. Two things have boosted expectations, firstly the last poll before the vote that showed the No camp gaining a solid victory of 53% to 47%, however, the Ipsos Mori poll suggests that the No camp could win by an even slimmer 51% to 49% majority.

The second was a rumoured leak on Wednesday evening that the postal votes that had been counted already were for a resounding No. However, even at this late stage it looks too close to call, and we won’t get a definitive answer until the early hours. The results will be released between 0200 – 0600am tomorrow. By 0500 am we should have a pretty good idea as 95% of all votes should be counted, however when Aberdeen announces who has won at 0600am, the victorious side is expected to be revealed.

Opening a can of worms

While opinion polls may point to a No win, referendums based on national issues tend to draw out huge numbers of voters, 85% plus, so people could change their mind at the last moment. Thus, we may have to wait to the bitter end before we get Scotland’s final decision.

A shock win for the Yes camp could send the pound flying south, potentially opening the door to 1.50 or even lower, while a victory for the No camp could trigger a knee-jerk reaction higher for the pound and the FTSE before, running out of steam.

Don’t bank on a No vote protecting the pound

Even if the No camp wins today the upside could be limited for the pound. Newspapers in the UK are reporting that a majority of Conservative MPs at Westminster oppose some of Cameron’s plans to give the Scots “Devo max” in the event of a no vote. This would give Scotland greater legislative and spending independence even if they vote No today.

“Devo Max” was an option that Cameron originally ruled out for Scotland ahead of this referendum; however, as the polls have narrowed in the last couple of weeks it has come back on the table. This has ignited the ire of Conservatives down south, who won’t let Cameron dole out “financial party bags to appease Mr Salmond,” as one MP so eloquently put.

This highlights the hole Cameron may have dug for himself. Even a no vote could lead to a bitter clash with his party’s back benchers, and if his party lose faith with him this close to the next general election, which takes place in May 2015, he could find competition from within his ranks – BoJo for PM anyone?

From a market perspective, after we get over one political hurdle, another could be lurking in the wings, thus the pound could fall victim to buying the rumour of a No victory, while the selling the fact. If Scotland is able to demand new powers and more money from Westminster, who is to say Northern Ireland, Wales or even regions within England won’t do the same? If Scottish independence is rejected today, the era of centralised power in Westminster could end up dying a slow death.

GBP: damned if they do, damned if they don’t

Markets don’t like political uncertainty, so going forward the prospects for the pound could depend on the tension between the political situation in the UK and the Bank of England’s intention to raise interest rates. This week the UK had another solid labour market report, however the two MPC members who voted for rate rises did not manage to sway anyone to their hawkish camp at this month’s meeting, potentially because inflation remains weak. Going forward political uncertainty could threaten the UK’s economic prospects, which may cause the BOE to remain on hold.

Although these risks are theoretical at this stage, it seems the pound could be damned if Scotland votes yes, and damned if Scotland votes no, and a stronger pound could be a tricky proposition.

GBPUSD: the technical view:

Cable traders could require a stomach of steal if they decide to trade GBP over the next 24 hours. As a Yes vote gets priced out, GBPUSD has surged above the 1.6300 handle, however, it lost steam around 1.6409 – the high so far on Thursday. Some nerves seem to be creeping in as we get closer to the results. Thus, we expect any move back to 1.6400 to be faded by the market as we lead up the results early Friday morning.

In the event of a yes vote, the market seems to think that a spike to 1.66 is not unreasonable, however, as mentioned above, if a Scottish No vote causes political problems at home then we could see some sellers start to gather at this level, with some coming in to square positions to see what comes out of the weekend negotiations at Westminster.

If Scotland surprises the market and votes Yes then we could see 1.60 very quickly in GBPUSD, and potentially back to 1.50. Overall, we think that a Yes vote could trigger a much larger reaction than a No vote for GBPUSD, and any bounce in GBPUSD on the back of a No vote could be short-lived.