Sterling Volatility Spikes To 3-Year High As Scottish Independence Nears

The dramatic rise in support for Scottish independence is nowhere more evident than in GBPUSD implied volatility, which has soared to 3-year highs as The Guardian reports a further poll showing next week's referendum is on a knife-edge with a gap of just 1 percentage point between yes and no. As one 'Yes Scotland' representative noted, "This new Scotland could be less than a fortnight away. But we must not be complacent. The scaremongering, dissembling and misrepresentation of the no campaign will be ramped up as we approach polling day." Of course, Scotland is not the only EU nation seeking separation, as we illustrate below, and as Goldman Sachs notes, there could be a broader impact on the risk premium across Europe as Scottish independence leads to other calls for more regional autonomy.


GBPUSD volatility has exploded...


As The Guardian reports,

A dramatic surge in support for Scottish independence has been confirmed by a further poll that shows that next week's referendum is on a knife edge, with a gap of just one percentage point between yes and no.


The poll by TNS found that support for independence has jumped by six points in the last month, putting the yes vote at 38% and the no vote at 39%, wiping out a 12-point lead for the pro-UK campaign led by former chancellor Alistair Darling.


The switch in support will delight the yes campaign but deeply alarm their opponents, coming after a YouGov poll found the pro-independence vote had a narrow one-point lead for the first time.

But it's not just Scotland... (via Armstrong Economics)


Which, as Goldman notes, may have broader implications for risk premia across Europe...

The implications for both Scotland and the rest of the UK of Scottish independence, in terms of factors including growth, currency and how debt and assets are divided, are highly uncertain and, as such, deriving the implications for equities is conditioned by that high degree of uncertainty too. With this qualification in mind, we consider a number of potential short-medium-term impacts for the equity market should we see a ‘Yes’ vote on September 18:

For companies based in Scotland or those with large Scottish assets (such as the utilities) there would likely be, at least in the short term, higher uncertainty with respect to these assets; these represent only 2.7% of the FTSE 350;


Indirect impact on all UK equities from higher uncertainty; UK equities may prove especially sensitive to this, as the holders of UK shares have become increasingly international in recent years (50% held outside the UK);


A further fall in sterling; this ought to be good for UK stocks given the high foreign sales of listed stocks (c.80% for FTSE 100 names, c.50% for FTSE 250). We estimate the impact on FTSE 100 earnings would be around 4% for each 10% move in sterling; the pound has already fallen 5% versus the dollar since July and around 2.5% in trade weighted terms;


There is a chance of a short term negative shock to growth as a hit to consumer and business confidence delays or stalls investment and spending plans across the UK. To some extent, this ought to be countered by the easier financial conditions provided by the fall in sterling and, most likely, by a more dovish policy stance from the BoE than would otherwise be the case. The FTSE 250 would be more sensitive to a UK growth disappointment; FTSE 250 earnings are highly correlated to domestic growth and have a beta of over 5x to moves in GDP.

Finally, there could be a broader impact on the risk premium across Europe as Scottish independence leads to other calls for more regional autonomy. Separately, Scotland would have to negotiate with the European Union as to whether it would remain a member of the EU and this again could led to additional rifts within European as well as UK politics.

Companies with direct exposure
The table below shows the companies in the FTSE 350 with Scottish cities as headquarters. This list represents just under 3% of the FTSE 350 by market cap (we have excluded investment companies). The stocks have performed roughly in line with the market, year to date, but have underperformed by around 3% since June (see chart). Of course, this is not comprehensive; not all companies with large direct exposure to Scotland have their headquarters there. Our utilities team highlights the impact of Scottish independence in European Utilities: Uncertainty ahead of Scottish independence vote high for SSE, IBE, September 4, 2014. For these stocks, they face a potential tax on generation and funding risks for Scottish renewables. A new regulator in Scotland may also lead to a review and possible change to allowed returns.

A spike in uncertainty for UK equities
If Scotland votes 'yes', a prolonged period of negotiation would follow between Scotland and (the remainder of) the UK over the terms of the separation (prior to the separation being completed on March 24, 2016). The issues that would require negotiation include whether and under what terms the newly-independent Scotland would be able to retain Sterling as its currency, and how existing UK government debt would be split between Scotland and the remainder of the UK.

The uncertainty is likely to weigh on UK equities, not least because so many international investors now have significant stakes in the UK stock market (see chart). UK pension and insurance companies - traditionally the dominant investor in UK equities - continue to sell their quoted UK equity exposure at a pace of £5-10bn per quarter, a selling pace which has shown no signs of slowing (see second chart below). International investors have generally been net buyers, absorbing some of this selling, but, in our view, they are likely to be more sensitive to UK-specific uncertainty than domestic-based investors, who have greater need of sterling investments to match their liabilities.

A fall in sterling; A positive for the FTSE 100 and more internationally exposed names...

We've already seen a large downward move in sterling in recent weeks as the 'Yes' camp has gained momentum; versus the dollar, sterling is down over 5% since July. FTSE 100 stocks have on average only 22% of sales to the UK so they should benefit from anything that pushes down sterling even if it's at the expense of UK growth. In terms of earnings, a 10% fall in sterling in trade-weighted terms would we estimate have a roughly one-for-one impact on the sales of companies with exposure; so, for the FTSE 100, with roughly 80% non-UK sales, this would add about 8% to sales. However, based on analysis we've done Europe-wide for companies, we find only around half of currency moves get down to the bottom line given some is absorbed by shifts in margins. We estimate the impact on FTSE 100 earnings would be around 4% for each 10% move in sterling.

For the FTSE 250, around 50% of sales are non-domestic, so the impact on sales growth of a 10% move down in sterling would be to add 5% to sales, all other things equal, but only around 2-3% to profits.

...but growth implications would weigh on the FTSE 250

Ultimately, however, the move in sterling, especially for the FTSE 250, is likely to be more than offset by the economic impacts on confidence and uncertainty. The relationship between FTSE 100 earnings growth and UK GDP is not all that strong: the correlation has been 38% since 1994 with a beta of earnings growth to changes in GDP of slightly over 3x. This seems high but is probably a reflection of the close relationship between UK GDP and international growth, and it's the latter which is most likely driving FTSE 100 earnings (see chart below).

For the FTSE 250, the correlation between earnings growth and UK GDP has been higher, at over 50%, and the beta of earnings to GDP is over 5x; this is a reflection of the higher exposure to the UK and the more cyclical nature of the companies in the index with high weights in industrials and financial services (see second chart below).

The chart below shows the performance of UK domestic-exposed companies relative to international ones with the trade-weighted pound. In recent weeks, as the pound has fallen the domestic names have underperformed. However, the move has not been large and in late 2012 and early 2013 sterling fell sharply in trade-weighted terms but the domestic names performed well, as growth was picking up in the UK but weak elsewhere.

We continue to believe growth, as much as FX moves, will be critical driver of performance.

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And just two weeks ago, no one had given it a thought (aside from us) and now...

"It is too close to call and both sides will now be energised to make the most of the last few days of the campaign and try and persuade the undecided voters of the merits of their respective campaigns."


"This new Scotland could be less than a fortnight away. But we must not be complacent. The scaremongering, dissembling and misrepresentation of the no campaign will be ramped up as we approach polling day."