Fiscal Deal: Dollar Bears The Brunt

Was a fiscal deal ever in doubt? US lawmakers certainly have the flare of the dramatics for delivery. The two-week standoff between the Republican-led House and the White House came to an end earlier this morning, and in the nick of time, just ahead of the Treasury-imposed default deadline. The main result for capital markets was the ability of US lawmakers to “kick the can.”  Everyone else was only interested in how far. They got their answer fair and square. The US government will be funded through Jan 15 and debt limit extended through Feb 7th, with the Treasury granted the authority to use extraordinary measures to extend debt limit through March of  2014. This again is only a temporary reprieve – investors will be mulling over the same situation in a couple of months.

The US’s credibility overseas will certainly be put to the test. The never was any real fear that the country’s reputation of being the primary issuer or reserve currency of choice would be called in question, despite China inquiring about the ‘dollars’ attributes. The toughest task will now be how credit agencies perceive the US’s credit worthiness and the country’s investment grade. China’s Dagong rating agency has beaten the others to the punch this morning and has added more woes to the “mighty” dollar when it cut the US sovereign rating to A-.

Prior to that, the USD began the day well contained within recent ranges. However, the greenback has maintained its vulnerability to weakening as the market begins to look ahead to next year. There will be more difficult fiscal issues to be faced by US lawmakers. None of it will have an easy route and is bound to complicate the Fed’s policy outlook. So now that the window dressing has been completed, markets will want to be relying on the hard facts. The lack of US fundamental data has had a severe impact on both volatility and volume across the asset classes over the past 16-days in particular. Investors should now be expecting a plethora of backed up data to be released fast and furiously.

The Bureau of Labor Statistics (BLS) previously said it would take three-working days to prepare the non-farm payrolls report after the government reopens. The paperwork to end the shutdown should be done on Thursday so that puts the non-farm payrolls release at Tuesday at the earliest maybe even longer. Retail sales and inflation data are other top-tier indicators that have been delayed.

At the moment things are not what they seem. Smart money would probably have bet on a debt ceiling deal being done and would have looked at the historical reserve currencies of choice – CHF and JPY – and believed that their safe haven status would have been greatly reduced. So far, that is not the case. Perhaps all the dramatics will be expected to take some time to filter through the system. Until then, both the JPY (98.06) and CHF (0.9051) are experiencing new found life against the dollar. The across board dollar weakness has brought the 17-member single currency back to within striking distance of this years peak €1.371, certainly a vulnerable target on all techies radar.

Even sterling is managing to get in on all the dramatics. This week’s double bottom base in GBP outright opens up £1.6123 with the prospect of further gains towards October 1st 1.6259. Retail sales data this morning (+1.5% Q3) is certainly helping the pound maintain its strength momentum. Rising consumer spending last month is obviously the net contributor (+60% of economic growth) and supports expectations that economic growth accelerated this quarter. However, beware that doubts persist over the durability of the consumer revival. Price inflation remains high (+2.7%) and earnings growth this week sank to a record low in the three-months to August.

The announcement of the deal in the Senate has provided some relief to US Treasuries across the curve, most significantly in Bills (short-end) where the market was pricing in a typical default scenario. Now that a deal is in place “event risk” has been put on hold – kicking the can for a few months does the trick – investors should expect the uncertainty that has been ever present this month to abate. Particular in yield products – if they start to rally aggressively in the short term the market will want to be selling into it – that has been the game plan for most of this year as dealers anticipate that US 10’s will limp out of 2013 yielding somewhere between +2.75% and +3%.

Investors should expect this market to tread lightly. The mix of a temporary resolution and the recent Yellen nomination should be a plus for risk. However, riskier assets have not performed accordingly of late. Investors are expected to be gun shy at first and wait for more compelling economic data to be delivered before throwing their full enthusiasm into a trade. Under this scenario the market will be playing the contained range trade until they are utterly convinced somehow.

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Dean Popplewell

Dean Popplewell

Vice-President of Currency Analysis and Research at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell