The cost of hedging against near-term currency swings from a possible ‘yes’ vote in Scotland’s independence referendum jumped to a 13-month high yesterday, as more hedge funds sought protection from wild fluctuations in the pound.
With less than two weeks to go before the vote, a YouGov survey for the Sunday Times newspaper put the ‘yes’ to independence campaign at 51 percent against the ‘no’ camp at 49 per cent, overturning a 22-point lead for the unionist campaign in just a month.
The pound is at the centre-stage in the heated Scottish referendum debate. Pro-independence leader Alex Salmond says Scotland will share the pound while Westminster has ruled it out, leading to uncertainty about the currency, debt and sharing of North Sea oil revenues.
Until late last month, most investors, including hedge funds, have been factoring in only a slight chance that Scotland will leave the three-century-old union.
But with the tightening of recent polls indicating that Scotland could be inching towards independence, investors are growing jittery.
Sterling fell 1 per cent against the dollar, to hit a near 10-month low of $1.6145. It was also down nearly 1 per cent against the euro, with the single currency trading at 80.17 pence, its highest in two weeks.
“The FX market also has some catching up to do. So far hardly any uncertainty about the outcome of the referendum had been priced in,” said Esther Reichelt, currency strategist at Commerzbank. “Over the next two weeks we should all be prepared for increased volatility in sterling exchange rates.”
The weakness in the pound – it has shed over 2.5 per cent in the past week against the dollar – saw the cost of hedging against near term uncertainty rise. The one-month implied volatility for sterling/dollar rose to around 9.35 per cent, its highest level since July 2013.
The two-month implied volatility also rose, but much less than the one-month and was trading at 8.15 per cent, highlighting concerns about the fallout from a potential ‘yes’ vote in the short term.
“It is the near term fallout that is leading hedge funds to seek protection,” said an options trader at a UK bank. “The longer term investors – the real money investors – have so far been on the sidelines.”
Until early August, most investors were bullish about the pound, given solid UK economic data and expectations that the Bank of England could be the first major central bank to lift interest rates from record lows.
Some of those bets have been unwound as wage inflation is still subdued, but it is the underpricing of a possible Scotland exit is what is driving the market, for now, traders said.
The one-month sterling/dollar risk reversals, a gauge of demand for options on a currency rising or falling, were showing their greatest bias for sterling weakness against the greenback in over two years.
One-month euro/sterling risk reversals, which flipped to show a bias for sterling weakness against the euro last week were also showing a greater bias for further pound losses.