There are two factors at wok on financial markets today. Firstly the big risk event (at least from the UK’s perspective) of Scottish independence has been nullified (to a certain extent), and secondly the continuation of the dollar strength that has been evident in the past few weeks.
Even though Scotland have voted “No” to continue the status quo, there is still much that needs to settled. The clamour for political change across the spectrum has been the major takeaway from a Scottish independence referendum which in the end was won reasonably comfortably by the “No” camp by a ratio of 55% to 45%. Although the immediate threat of bank runs, credit rating downgrades and flight from assets has been prevented, there will still be a certain amount of political uncertainty that needs to be resolved. It now appears that some sort of extended devolution will need to be agreed and this could take months to discuss and organise.
My outlook is actually that some positivity can be taken out of all this. The United Kingdom remains intact. Also for all the bluster of the “Yes” campaign which included apparent bullying and intimidation of journalists and businesses, there was a clear majority. It must be incredibly difficult to run a campaign on a “No” message, a message for no change against the word “Yes” and a vote for something new. However, the economic stability that comes with 307 years of union won the day, with head ruling over heart.
Politics in the UK needs to be more representative of the masses and it is a strength of the democratic process in the UK, that we can take this message without resorting to violence and mass demonstrations. If, when the dust settles, the people of Scotland and for that matter, Wales, Northern Ireland and England can feel better represented, then is this not a good thing?
As for Sterling, the markets had already come to the conclusion on a “No” victory during yesterday’s session. It is interesting that the peak of the retracement in Sterling at $1.6525 (which is also a key resistance from the old key lows from late August) came before even the first region released its results. Since then, Cable has been volatile but has begun to unwind. The overnight At The Money Sterling/Dollar options have dropped significantly already, suggesting a normalisation of volatility is now under way.
However, expect the volatility to gradual recede as traders reprice the fair value of where GBP/USD should be trading. Remember that the dollar has continued to strengthen throughout the past few weeks and this should ultimately continue. The spread of market expectations of when the two central banks will hike rates continue to narrow. Short Sterling Interest Rate futures are pricing in a March 2015 rate hike, whilst the US interest rate futures are pricing in June 2015. The recent fall in the UK inflation data, along with lack of wage growth and the minutes from the latest Bank of England MPC meeting means that the expectations of a UK rate hike are being pushed back. Although the risk of Scottish independence is no longer a factor, the doves are still in control. The initial reaction on the Gilt curve is for the front end (short dated gilts) to be sold (in effect taking out the risk of a Scoxit).
The FTSE 100 is also stronger today, but remains well below its 6905 peak for 2014. I do not think that this is the fundamental event that will drive a breakout and I can see UK equities continue to struggle, at least until the next earnings season.
The dollar strength that has come since the FOMC meeting on Wednesday is once more driving Euro/Dollar lower, Dollar/Yen higher and keeps gold under pressure. EUR/USD is eyeing a test of yesterday’s low at $1.2833, below which would open the 61.8% Fibonacci retracement support at $1.2786 and then the huge July 2013 lows at $1.2750. Dollar/Yen will now look to use the support in the band 108.00/108.50 as the basis for further gains and a test of 110.65 seems to now be just a matter of days away. Gold is also under pressure once more. Finding a ceiling around $1240/$1242 resistance seems to have been key and the downside pressure (driven by the strong dollar) is keeping the bears firmly in control for a retest of the $1184.50 key December low. A near term rebound should be viewed as a chance to sell.