Little respite for the dollar

Given that the government shutdown has reduced the number of market moving US data releases on tap, tensions surrounding the US budget and likely debt ceiling impasse continue to weigh on sentiment. Signs that senior Republicans are becoming less focussed on defunding Obamacare hint at potential for a compromise. However, a deal looks a long way off and nervousness is set to grow ahead of the October 17 debt ceiling deadline.

Reflecting this, risk measures rose overnight, with the VIX “fear gauge” spiking higher and equity markets lower. Safe haven currencies including CHF and JPY remain well supported against this background although gold prices have been range bound. Giving some relief from politics markets will be able to focus on the onset of the US Q3 earnings season this week.

The USD is susceptible to further slippage as traction towards a US budget deal remains out of reach. The USD index has now dropped by over 5% in the last three months, undermined more recently by a potential delay in Fed tapering and lower US Treasury yields. Uncertainty about the economic impact of the budget delay and prospective failure to raise the debt ceiling over coming weeks suggests that any upside traction for the USD will be extremely limited.

What is clear is that the longer the delay in reaching a deal the bigger hit on the economy and in turn the bigger the pressure on the USD. A delay in the release of trade data originally scheduled for release today will mean that market angst over the political impasse will be the bigger driver of the USD today. The USD index is set to edge further below the 80.00 level over coming days.

JPY is a clear beneficiary of the malaise in the US over recent days and looks set to strengthen further in the short term especially as risk aversion continues to increase and US yields remain constrained. The day’s ahead will be particularly important for the JPY from a domestic policy perspective too. Japan’s parliament meets from October 15 to December 16, marking a crucial period to pass legislation on Prime Minister Abe’s “growth strategy”.

Given past disappointment with Abe’s “third arrow” markets will look for strong evidence that reforms will move Japan to a higher and non deflationary growth trajectory. This is by no means guaranteed. Further disappointment would imply a firmer JPY. Having tested its 200 day moving average around 96.72 near term technical support for USD/JPY is seen around 95.92.

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