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Daily Agenda: U.K. Braces for Scotland’s Independence Referendum

RBS prepares for a major IPO of U.S. unit; EU puts Russian sanctions on hold; oil futures drop.

The grind higher in U.S. equities has analysts divided between a bullish majority and a highly vocal group of those that predict a near-term correction as a brightening economic backdrop is offset by historically high valuations. A more complex market risk factor facing investors is asset-class correlation. In a note this morning, Nicholas Colas, chief market strategist at New York–based global brokerage firm ConvergEx Group, wrote that relationship between equity markets in the developed world, as well as individual sectors and assets such as commodities and bonds has tightened in the prior two months. “Last month’s average sector correlation was 76.5 percent but that is actually higher than the previous month’s reading of 74.7 percent and the 69.9 percent of two months ago,” he writes. “The same observation holds true for EAFE (Europe, Australasia, Far East) developed economy stocks.” With the U.S. dollar continuing to be boosted by Bank of Japan and European Central Bank policy actions, not to mention Scottish jitters, in a low-volatility environment, macro factors continue to dominate global market sentiment.

Production rises in the U.K. A positive data point emerged today out of the shadow cast by the September 18 Scottish independence vote over U.K. markets. July industrial production data released this morning registered a month-over-month expansion of 0.5 percent, exceeding consensus forecasts. On a year-over-year basis, the release constituted the 11th consecutive expansion. Critically, the increase in industrial activity was led by electrical output, which is typically viewed as a bullish signal of overall economic activity.

Bank of England Governor Mark Carney gives talks. Carney spoke today in Liverpool at the annual meeting of the Trades Union Congress. The TUC is pushing for increased wages in the U.K., including a minimum wage of £10 ($16.13) an hour, a theme that resonates with Carney’s concerns over the current state of the economy. Tomorrow he is scheduled to address a parliamentary committee, where Carney will likely weigh in on the potential impact of a Scottish secession.

Royal Bank of Scotland spin-off to go public. Royal Bank of Scotland filed yesterday for a U.S. IPO of its U.S. subsidiary Citizens Financial Group, with a target of $23 to $25 per share. RBS would retain a 25 percent stake. If successful, this offering would be the largest financial IPO since 1999. RBS had previously sought a buyer for the U.S. unit, owned by the bank since 1988, without success.

EU Russia sanctions on hold. European Union leaders agreed yesterday to increased restrictive measures against Russia in response to conflict in eastern Ukraine. The scheduled rollout of the new restrictions on financial transactions will be delayed however, as some states, notably Finland, seek to restrain action until the present cease-fire in eastern Ukraine is successful.

Oil futures drop. Brent crude futures crossed below $100 in trading this morning, trading at $99.72 per barrel at one point yesterday, the lowest price point since June 2013. West Texas Intermediate for October delivery dropped to $92.34, the lowest price in eight months. Forecasts in the U.S. are for a marginal contraction in weekly EIA crude stock levels today, but the trend in supplies for North America broadly continue to signal expansion.

Portfolio Perspective: Scotland Becomes an Unwelcome Addition to Geopolitical UncertaintyAdrian Miller, GMP Securities

Just when the market thought it had accounted for all of the flash points that could impact market tone and direction, Scotland threw its hat into the ring of worry. The independence referendum has been kicking around for over a year, but the market has largely ignored the vote since the “no” camp had long held a significant majority. But that has been changing of late and the shift in momentum was highlighted by a YouGov poll over the weekend that signaled the “yes” camp now has a 51 percent majority.

While a Scottish “yes” vote on September 18 would unlikely have a significant long-term impact on the global economy and financial market, it would surely shake the U.K. and Scottish economies and financial markets, particularly the pound sterling and Scottish banking shares. Much is unknown, however, most notably whether Scotland would be able to hold on to the pound, remain supported by the Bank of England should a future bailout be required and remain in the EU. The answers to these questions have far-reaching impact on Scotland’s current debt load, the U.K. economy — Scotland is 25 percent of GDP — and even political outcome in the U.K. parliament, Absent Scotland’s representatives, the Conservative Party would grow stronger in the U.K. parliament, with the Tories decidedly more suspicious of the EU. Remember, the U.K. has an EU referendum in 2015.

Having said all of that, we must remember near-term market turmoil will likely be limited, as the ECB is steadfast in its support of the euro zone. Moreover, while the Bank of England has been discussing how they may begin to lift rates, a potential financial market dislocation tied to a “yes” vote could postpone any policy tightening. We look for the U.K. government to ramp up negotiations with the Scottish parliament to gain the upper hand by providing support for the “no” votes.

Adrian Miller is the director of fixed-income strategies for GMP Securities, a wholly owned subsidiary of Toronto–based GMP Capital.

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