- Sterling and UK assets being undermined by Scottish referendum uncertainty
- Short euro positioning in extreme territory, but not yet ready for correction
- Headline US nonfarm payrolls influenced by temporary factors
Break-up risk undermines sterling
Over the weekend, a YouGov opinion poll showed that the Yes vote for Scottish independence has taken the lead with less than two weeks to go. According to the YouGov poll for the Sunday Times, 51 per cent of voters would vote for independence, and 49 per cent against, excluding those undecided. The poll weighed on sterling and UK equities. In the gilt markets, the 10y was flat, although the short end rallied as investors scaled back expectations of rate hikes. The poll raises the prospect of a sterling currency area break-up as the UK government has ruled out a currency union with an independent Scotland. This in turn raises questions about the division of assets and liabilities and the possible re-domination of the balance sheets of Scottish entities. In addition, the SNP has said it would not take on any of the UK’s debt obligations if it cannot keep sterling. In this case, the UK’s government debt ratio would rise. In the case of a Yes vote, the two governments have pledged to work constructively together to reach separation agreements, while the BoE has prepared a contingency plan to ensure financial stability in the interim period. Obviously the situation creates a lot of uncertainty, which will not lift until either there is No vote, or a concrete and credible separation plan is announced following a Yes vote. In the meantime, downside risks to sterling look significant.
Euro and dollar positions in excessive territory
The non-commercial positioning data from the futures market show that net euro and net US dollar positions have moved into excessive territory. For example short euro positions are approaching the peak seen in May 2012, during the dark days of the sovereign debt crisis. Another example is the sharp rise in long dollar positions and also in net positions. These large open positions could undermine the downward trend in EUR/USD at some point. However, we do not believe that a change in trend is imminent. If that were the case, currency markets would have reacted differently to the weaker than expected US employment report. If currency markets would have been worried about the dollar’s rally, they would have taken profit on dollar longs and euro shorts. Therefore, the dollar rally and euro sell-off have more room to go in our view. We remain confident that EUR/USD will ultimately test an break 1.28 this year or at the start of next year, while we expect USD/JPY to rally to 110 at the end of this year.
Special factors influence August’s non-farm payrolls
Last Friday, we saw a disappointing labour market report and our view is that it was unlikely to represent a trend. Other reports released prior to this report had been showing that the recovery was on firmer footing. Looking closely at the details we have seen that the weaker than expected nonfarm payrolls report (142K) in August, is the result of a number of special factors. To begin with, August is a month for summer re-tooling shutdowns in the auto industry. Data from the past 5 years show that August is recurrently below the average job growth. This time, the manufacturing sector added no jobs in August. But we would expect this to revert next month. Secondly, the fall in retail sales (-8K) last month is partly explained by employment disruptions at a grocery store chain in New England as workers walked off in solidarity with the CEO. The CEO is back and workers should return. All things equal we should see a rebound in this sector next month, especially given the background of decent consumer demand. Given the impact that special factors have on the labour market report, the FOMC has chosen for a more holistic view of the labour market and focuses on a broad range of indicators. Tomorrow, July’s Job Openings and Labour Turnover Survey will be released. Although this report lags the official labour market report by one month, it has acquired significance as a complementary measure of the labour slack in the economy. We expect that the report on job openings to continue showing a positive trend. We think that the weak payroll numbers will not influence the Fed’s view of the outlook.