Kingdom Stays United, Sterling Rally Stalls $1.6525, Yen Slumps

The results are not final or official yet, but it is clear that Scotland voted to remain part of the United Kingdom in a vote that was not as close as the opinion polls suggested. The "wisdom of crowd" type of information from the formal and informal markets had anticipated this outcome. Sterling poking through $1.6400 in North America yesterday, sterling advanced to $1.6525 in Asia before pulling back a cent. Recall sterling bottomed on September 10 near $1.6050. The cap we identified between $1.6500 and $1.6600 remains intact.

In a firm US dollar environment, the sterling opportunity may reside more on the crosses than against the greenback. With the referendum out of the way, there is no reason not to expect the BOE to raise rates early next year, still likely before the Federal Reserve. The political uncertainty shrouding the referendum overshadowed, to some extent, the favorable macro economic considerations. The divergence theme, with the US and UK beginning to normalize monetary policy while the ECB and Bank of Japan are still with a heavy foot on monetary accommodation, is a key feature of the investment climate.

Sterling has exploded over the few sessions against the yen, for example. On Sept 8, it has broken down to JPY169.35. Today, it moved above JPY180 for the first time since 2008. The next target is near JPY184. The euro is heading for the July 2012 low near GBP0.7755. Recall, the euro briefly poked through GBP0.8000 on Sept 16, and today neared GBP0.7800.

There had been some concerns that a small victory for the unionists would spur concerns that this will be a recurring issue as some drew parallels with the Quebec experience. While we recognize this as a possibility, we suggest this is not an immediate issue. The victory appears to be solid, and the terms of the referendum were as favorable for the nationalists as could be imagined (16-year old voters, non-residents can't vote and a simple majority was needed). The main political issue now is not whether Scotland stays in the UK, but whether the UK stays part of the EU. Cameron faces a backbencher revolt over the issue and a UKIP that enjoys some momentum.

The other main story of the day is the continued yen weakness. It is off about 0.3% today, with the dollar moving above JPY109. It is now off 1.6% on the week, the poorest performing of the majors. Although yesterday the junior member of the governing coalition expressed some concern about addition yen weakness, BOJ Governor Kuroda was clear today at the G20 meeting that he did not see major problems with the current move. Of course, he was quick to add the politically correct disclaimer that he was not in a position to discuss specifics.

The decline in the yen is helping to lift Japanese stocks. The Nikkei rose 1.6% to near seven year highs. Exporters generally did well. The weakest equity sectors were the domestic industries like energy and utilities. With today's gains, the Nikkei has turned positive on the year. The weakness of the yen is also expected to revive price pressures, which stabilized in recent months. Separately, the Japanese government cut its overall economic assessment for the first time in five months. Its claim that "private consumption appears to be pausing" is a thinly veiled recognition that the sales tax increase is having a longer lasting impact than expected. The increase in the assessment in July seems like cheerleading.

While Kuroda has been clear, as all central bankers say, it is prepared to do more if needed, but we do not see any sense of urgency. In fact, the yen's depreciation seems to reduce the need for additional formal monetary stimulus. Instead, the economic assessment is signal of the need for a supplemental budget, and may intensify the debate over the next leg of the sales tax increase for October 2015.

Meanwhile, the market continues to digest the implication of the small take down at yesterday’s inaugural TLTRO. Generally speaking, while many are saying the program is a failure, others, including ourselves, want to reserve judgment until the December offering. Still, the peripheral bond market rally has resumed. The focus today will be on the repayment of the LTRO funds. The issue is whether the new TLTRO funds will expedite the repayment of those older and somewhat more expensive funds. Separately, Moody’s is set to announce its review of France’s credit rating. There is some risk for a downgrade, which while making for poor headlines, would be a catch-up move as S&P has already put the sovereign rating at AA.