Volatility returns to currency markets on the back of Scottish referendum jitters
15/Sep/2014 • Currency Updates•
Sharp moves and event risk were the norm last week in the FX markets. The uncertainty regarding the referendum outcome was an obvious driver, but far from the only one. Poor economic performance in Europe and Japan, the increasing certainty of rate hikes in the US in the first half of 2015, and increased tensions with Russia are all increasing volatility and (to a lesser degree) diminishing investors’ appetite for risk. After a week of sharp moves, sterling managed to end not far from where it had started, as new polls showed the No camp is still ahead. However, FX implied volatilities (a measure of the price of insuring against FX risk) are up almost 50% from the multi-year lows they hit during the summer – levels more in line with historical averages. Next week promises to be at least as volatile as the referendum date nears. Stay tuned.
Last week’s polls on the Scottish referendum suggest that the ample No lead has mostly evaporated. After falling sharply on Sunday night, sterling kept falling through Wednesday morning, before a new poll showing the No option is still ahead was published, and GBP rallied to end the week only moderately down against the dollar. Markets ignored all other news, data or developments, as sterling trades primarily as a proxy of expectations for a No vote on Thursday. However, Governor Carney did state in a speech that the BoE’s best guess for the first hike in rates is the first quarter of 2015. This is not a surprise, but we do think that there is an implicit assumption that Scots will reject independence on Thursday behind that forecast.
We got some decent economic news out of the Eurozone, for a change. Industrial production rose in July, up 1.0% MoM. This suggests that manufacturing may make a modest positive contribution to third-quarter growth. However, the weakness in retail sales implies that private consumption remains stagnant. Further, overall strength masked weakness in the periphery. Italian and Spanish industrial production both shrank significantly in July, while Germany surprised to the upside. This is not the mix the ECB wants to see. We therefore maintain our forecast for below 1% growth in the Eurozone as a whole in Q3 and further easing by the ECB before the end of the year.
Economic news out of the US was modestly positive again last week. August retail sales came out nicely above expectations, and figures for previous months were revised upward. This means we can probably expect a decent rebound in consumer spending in the third quarter. Together with better-than-expected trade and housing numbers, the US economy is on track to post growth above 3% in the second half of 2014. Strategists are pushing back their expectations for the first Fed hike; we stick with our out-of-consensus call that the first major central bank to raise rates will be the Federal Reserve, rather than the Bank of England.