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314-year alliance between England and Scotland could fail: what does it mean for the markets?

The week, which could lead to the final collapse of the 314-year alliance between England and Scotland, will force the City’s trading offices to focus on possible upcoming market disasters. When the Scots vote on May 6 on whether they should hold a second independence referendum, fund managers and sales strategists see the potential for massive chaos in the UK economic environment in the coming years. Yet, ignoring the echoes of the early days of the Brexit poll, few are hedging for a disruptive outlook, while the derivatives market is showing no signs of impending stress.

Chart: Bloomberg

It is not clear whether the UK government will agree to another referendum, even if pro-independence parties win a majority on Thursday. But as the vote reawakens troubling memories of the UK’s secession from the European Union, fund managers are dusting old rulebooks on how to trade binary risk event when everything is time dependent.


“You would be faced with tremendous uncertainty, financial chaos and recession,” and a 10% devaluation of the pound, said Mark Nash, financial manager at Jupiter Investment Management.


Nash is not yet hedging such a scenario as is the market.

Median of forecasts, according to Bloomberg survey: until June pound will hold at $ 1.39. However, a handful of investment analysts have opted for bearish forecasts. Strategists at Credit Agricole SA recommend selling the pound short against the dollar, among the reasons – the political risk over the independence of Scotland. Barclays Plc has dropped its call to go long on the pound against the euro due to potential pre-election volatility. Credit strategists at UBS Group AG cut their outlook on a select group of UK bank bonds to neutral from above market, warning that a “long position on UK credit” could be unprofitable due to the risk of a referendum. One thing is certain: if the situation escalates, money managers will have to act quickly. Odds show that a repeat of the 2014 referendum in which Scotland voted to stay remains a distant prospect.

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“Markets ignore and ignore risks again and then suddenly panic. I have a feeling this could very well be the case with the Scottish independence issue, ”said Jane Foley, head of currency strategy at Rabobank. “I tell our clients that they need to know that even if it may not affect the pound right now, it would be reckless to ignore it because it could suddenly enter the market’s agenda.”


The consequences of separation will be enormous. Negotiations will be required about what currency an independent Scotland will use, whether it will take on some of the British public debt and what trade agreements it will have with the rest of the UK. The Scottish National Party (SNP) also harbors ambitions for Scotland to join the EU, a situation that will create tremendous border and trade tensions if the border fencing issue is resolved. Northern Ireland in the case of Brexit is an example of this.

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“I’m wondering if the markets have really taken into account the full implications of these choices,” said Julian Howard, director of multi-asset management at GAM Investments, whose portfolios are strategically set to depreciate the pound sterling. “That would be much worse than Brexit, as Scotland is much more closely tied to the UK than the UK is to Europe. We’re talking about a connection to the 1700s, not the 1970s. “


The location of financial institutions may also change. If they stayed in Edinburgh, Scottish banks would lose support for the Bank of England’s quantitative easing program and become less creditworthy, according to Charlie Parker, managing director of high net worth investments at Albemarle Street Partners. This is a kind of risky event that allows for the career of those who are far-sighted enough to get it right.

At Nomura Holdings Inc., strategist Jordan Rochester was part of the team that developed the model to predict the outcome of the 2014 referendum early. His political analysis of secession from the EU led to him being nicknamed Mr. Brexit. Now he says the pound could drop as much as 6% if Scotland votes to exit, depending on what the price will be before the outcome. But even he is not worried about Thursday’s upcoming elections, and says the pound could even rally if the SNP fails to win more than half the seats, some polls show.

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However, the call for independence could intensify again after the Greens vote count, and the date of the referendum could cause serious hedging.


“The market will look at the vote as a blueprint for a new referendum (on Scottish independence) and treat it much more like a tougher vote than in 2014, when it was only last minute fears, not months “Rochester said.


Westminster is likely to resist any plans to get an independence vote by refusing to give the Scottish parliament permission to make it legally binding. This could turn into a lingering constitutional quagmire over whether the Scottish parliament can initiate a legitimate referendum on its own.

While the prospect of an active Scottish splinter scares traders, the derivatives markets remain calm. Options show that the cost of insuring pound fluctuations is well below recent peaks. The five-year change in risk in pound trading is close to the average since Bloomberg began collecting data in 2005.


“The difficulty in assessing the impact of these events on the markets is that even if we know they are on the horizon, we do not know when the markets will react and whether the status quo will ultimately continue,” said Shina Shah, currency strategist. Morgan Stanley. Her firm estimates there is a 30% chance of a referendum being held by the end of 2024. “There are so many unknown and further obstacles.”


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