The Brexit decision was always likely to create a renewed threat to the political union of the UK, and sure enough Scotland has called for a renewed referendum on independence. The economic argument for Scottish independence remains weak. Scotland’s fiscal position, combined with it’s ambition to rejoin the EU, would ensure years of painful economic austerity. Moreover, Scotland’s weak external liquidity position and the UK’s opposition to the country retaining the GBP means that the most realistic options for a future monetary anchor would be a currency board or, and far more appropriately, a floating exchange rate. Both options come with macro-economic costs. However, while economic arguments held sway over the Scottish electorate during the 2014 referendum, Brexit has weakened their impact: the UK government is embarking on an aggressive, multi-year policy of fiscal austerity, meaning that the choice facing Scottish voters would be to choose their path of fiscal restraint; Brexit means that Scottish independence could mean a path into the EU or EEA; the coalition of political parties that would fight against Scottish independence would be far more fragmented than in 2014. As the UK government moves towards a hard Brexit, the pressure for a second independence referendum is unlikely to dinimish, and will represent yet another factor that weakens the multi-year outlook for the GBP.
In the 6-months since we first undertook a detailed analysis of the Saudi Arabian economy, little has happened to change our conviction that the 30-year old USD/SAR peg is inconsistent with a world where the price of oil is increasingly inelastic to the policies of OPEC. Despite the recent pick-up in oil prices, Saudi Arabia is still faced with the challenge of a widening current account deficit and declining FX reserves, while the need to limit the hit to GDP of lower oil revenues has resulted in a 21.6% of GDP budget deficit. Some optimism has been generated by the government’s plan to fund a Sovereign Wealth Fund by selling part of Saudi Aramco. However, establishing a SWF aimed at generating non-oil income may in part be inconsistent with the SAR-peg in the current climate: the much mooted sale of a 5% stake in Aramco over the next 18 months would likely generate funds that are equivalent to the decline in Saudi FX reserves over the past 12 months. Long-USD/SAR positions in the FX forwards continue to be attractive, as a larger risk premium needs to be attached to the SAR-peg, while the carry cost of such a position continues to represent a small price for adding convexity to an investor’s portfolio
It has rarely been timelier for investors to embed a convex strategy within their portfolios, whether this be positioning for or hedging against out-sized, non-linear moves and trend changes within markets. The list of potential shocks grows ever longer and includes issues such as: a world economy struggling to sustain acceptable growth rates; the growing awareness of the downside risks to inflation in major economies; many policy-makers implementing ever more unorthodox monetary policies; the growing fear that the Fed has repeated the past policy errors of the BOJ and ECB in tightening monetary policy too soon. An additional risk factor, which will likely grow in importance, is the credit risk and secondary market implications of the collapse in commodity prices. Of particular focus for this note is the tension between the Saudi Arabian currency peg and the changed dynamics in the oil market where, firstly, the price of crude has become increasingly exogenous to OPEC members and, secondly, where Saudi Arabia appears to have changed supply policy in favour of preserving market share rather than the price of oil. For all the focus on Saudi Arabia’s current austerity programme designed to respond to the slide in oil prices, it is difficult to see fiscal policy being sufficient to remove the increased FX risk premium attached to the SAR-peg. Continue reading