Is U.K. Economy the Canary in the Coal Mine for G-7?

The British pound woke up on the wrong side of the bed at the start of this week’s trading in the currency market. The single currency tumbled below 1.2400 on reports that Scotland may call for a second vote on whether to secede from the United Kingdom.

The Times of London reported that Scottish First Minister Nicola Sturgeon may call for another independence referendum as early as next month. The call comes as a response to the U.K.’s plans to officially commence the Brexit process by triggering Article 50 around the same time.

During the Brexit election in June 2016, Scotland voted to remain in the European Union. But in September 2014, Scotland narrowly voted to remain in the U.K. during the first independence referendum.

It is unclear if Scotland’s second referendum would produce different results. Recent polls suggest that the Scots may still prefer to remain in the U.K., even though they voted against Brexit. Still, the second independence referendum could introduce an unwelcome note of volatility into what is already shaping up to be a highly contentious scenario. U.K. Prime Minister Theresa May’s administration vehemently opposes a second Scottish referendum.

If Scotland leaves the U.K., it could take the benefits of some significant oil rigs and refineries with it.

Scotland represents about 6% of the U.K.’s GDP and about 8% of its population. So even if it seceded, the economic impact on U.K. would not be substantial. But the Scots’ clear opposition toward Brexit could become a long-term political problem for the U.K. and would add an additional point of stress to the exit strategy.

However, the U.K. Parliament ultimately holds power over the independence decision. Just as it does with Brexit. And with Conservatives in the vast majority, the Parliament would reject Scottish independence even if the Scots voted for it. Ultimately, the vote would be simply symbolic. But it is precisely that symbolism that investors ignore at their own peril.

Brexit was effectively ground zero for the global populist movement that is sweeping across all the western industrialized nations. Whatever its political agenda, the unifying economic theme of all the populist movements is fracture. It is essentially withdrawal from the current multinational trade agreements while making more bilateral arrangements that create multi-polar rules and much greater fragmentation of markets.

Up to now, investors have blissfully ignored the underlying problems with populism, essentially betting on the fact that deregulation and lower taxation will offset any negative fallout from more protectionist markets. But the Scotland-U.K. rift shows that the current ideology of nation-first is rife for conflict even within the country’s own borders. That’s why the U.K. may be the canary in the coal mine for G-7, the western industrialized bloc, which includes the U.S., the U.K., Italy, Japan, France, Canada, and Germany.

Up to now, the U.K.’s economy has performed far better than most experts predicted as the country enjoyed the double benefit of remaining in the EU while having a markedly lower currency that helped make its goods more competitive. But lately, the U.K. economy has shown signs of slowing down as well as signs of unwelcome inflation from the weakening currency.

This week, currency traders will be watching the trifecta of U.K. PMIs – Manufacturing, Construction and Services – for any further signs of a slowdown in the economy, which could send cable lower for a retest of multi-week lows at 1.2200.

Meanwhile, U.S. investors should keep one eye on the developments across the pond, even as they listen to Mr. Trump’s address to joint houses of Congress, to get a reading on how populist economic policies could play out in the next several months.

Happy Trading,

Boris