Scotland’s moment of truth: Emotions versus rationality

Redacción - Jueves, 18 de Septiembre

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David A. Meier, Economic Research, Julius Baer

Scotland’s moment of truth: Emotions versus rationality

Today the Scottish electorate of roughly 4.1 million will vote on independence. Financial markets were relaxed on this topic during the first months of 2014, but recent polls have shown a dramatic rise in the share of ‘yes’ pledges, although on average the ‘no’ votes maintain a very narrow lead. Fears of a ‘yes’ are huge not only in the UK, but also in other European nations because of the precedence a Scottish devolution could mean for other regional independence movements. Indeed it will be a close call today, and it is clear that financial markets will jump at any indication on which direction the vote may take (final results are expected after mid-night, Central European time).

independence has always been an emotional question, whilst from a rational perspective it is not very appealing as it would first open more questions than solve problems. Which currency to use, how to split the oil and gas industry and share debt with the UK – are only some of the many issues which would have to be solved, besides inevitable negative consequences from the sacrifice of EU membership and capital flight out of Scotland. For the UK, the immediate loss of 8.3% of gross domestic product and a population of 5.3 million would clearly be painful, but also the message to the smaller member states (Ireland, Wales) and consequences for the current government at the next general election would be disturbing. It is all up to the Scots now –whilst we observe whether the pathos of a rightful nation suppressed by the English crown is strong enough to defeat economic rationalism.

 

In short: financial markets will react negatively on UK assets in case of a ‘yes’ and positively in case of a ‘no’. See on page 2 why a ‘no’ could lead to an only short-lived GBP relief rally, and why our UK equity market view would remain underweight.

 

David Kohl, Head of Currency Research, Julius Baer

ECONOMICS: FOMC signals steeper interest rate path

The actual decision after the two-day Federal Open Market Committee (FOMC) meeting was hardly a surprise. Asset purchases will be lowered by additional USD10bn and the remaining USD15bn will be conducted only until the next meeting at the end of October. The challenging part consists of the incremental steps of forward guidance. The hotly debated “considerable time” phrase − which describes the period of about six months between the end of asset purchases and the first rate hike – has remained in place; however the upward revisions of the appropriate rate at the end of next year suggests that the Federal Reserve (Fed) is prepared, at least, to hike rates faster than previously envisaged. The message was sufficient to please the bullish consensus on the US dollar with EUR/USD falling to close to 1.284 and USD/JPY marching towards 109. We maintain our view that the euro’s weakness is fundamentally unjustified but not yet extreme enough for us to become contrarian and count on a stronger currency. However, we see better chances that US dollar strength will persist against the yen, the Australian dollar and the British pound.

The more hawkish FOMC statement has pleased the bullish US dollar consensus despite Janet Yellen’s attempt to maintain a dovish message.

 

Markus Allenspach, Head of Fixed Income Research, Julius Baer

 

FIXED INCOME : TIPS suffer from low inflation, steeper rate outlook

Treasury inflation-protected securities (TIPS) were the underperformer of the day after an unexpected decline of consumer prices reported for August and a very vague Fed communication. Admittedly, Fed Chair Yellen began her prepared remarks on monetary policy with a bleak assessment of the labour market. In her view, there are still much too many Americans seeking a better-paid job, looking to work full time rather than part time or waiting to return on the labour market once the outlook improves. TIPS had a good performance between May and mid-August but have been losing ground since then as real bond yields have moved up. The real 10-year bond yield rose from below 0.2% in mid-August to 0.57% yesterday. In our view, the speech did not deliver any reason for higher real bond yields. In fact, in the separate survey of Fed members’ expectation of growth, inflation, unemployment and long-term Fed funds rates, most members indicated that they expect interest rates to stay low even after inflation has picked up. In other words, the Fed members still express their intention to ‘rather fall behind the curve’ which would be favourable for TIPS.

We added TIPS to our portfolio in May and July and continue to stick to this recommendation despite the recent setback. If Yellen is serious about job creation and stimulating the housing market, she has to keep the yield curve flat at the long end and to contain real bond yields.

 

Christoph Riniker, Head of Strategy Research, Julius Baer

 

Equities: Remain underweight on UK equities

Latest polls suggest a neck-and-neck situation on the Scottish vote, and financial markets do not like periods of uncertainty. As a consequence UK equities were confronted with heavy fund outflows last week. Supported by the ongoing relative underperformance of UK equities in a global context, we keep our underweight stance, since we do not see any relevant drivers for the time being. As outlined on the front page, there are several elements in case of Scottish independence which are still unresolved and would thus add further uncertainty. An independence of Scotland would most likely weigh negatively on UK stocks with Scottish exposure, which already underperformed ahead of the vote. Evidently, the opposite will be the case if the Scots vote against independence. In addition, there are a number of companies which could benefit from ongoing weakness of the British pound and vice versa.

A ‘yes’ would weigh on UK stocks with Scottish exposure, a ‘no’ bring some relief. In general we remain underweight on the entire UK market, due to lack of drivers.

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