Farce reigns and risk aversion rises - U.S shutdown and Italian political turmoil

Tom Tong01/Oct/2013Currency Updates

GBP

No data releases out of the U.K yesterday did not spoil the pounds party. Sterling toasted a 9 month high against a currency basket of its most traded pairs. Sterling reached its highest against the dollar since last December. Political uncertainty in the eurozone and U.S fueled the move. This coupled with the the recent release of good data across the economy, supported the unusually bullish trend towards the U.K economy and anticipated future gains. The sterling trade-weighted index saw 83.6, the strongest levels since January. This is widely expected to continue throughout the week. Carney articulating the BOE stance on QE last week, subdued some who felt a swing in QE sentiment within the BOE was highly probable. The clear forward guidance from Threadneedle Street is a welcome contrast from political and economic turmoil in the eurozone and the US, which is rocking the euro and dollar. Hence, sterling is seen as a solid alternative.

Sterling punched to new highs against the euro, with the gains coming from the Italian political storm. The Italian PM Enrico Letta said he would ask Parliament on Wednesday for a confidence vote after rouge ministers in Berlusconi’s party pulled out of the current PM’s government at the weekend. The Italian government is now hinged on possible collapse.

Sterling seized on American uncertainty exceeding last weeks gains with the debt ceiling crisis unresolved and a partial shutdown now in place.

FTSE was down due to most firms having U.S exposure. Data releases of note today include Markit manufacturing PMI with slight gains expected.

EUR

Eurozone inflation data CPI release was telling of the blocs rise from the mires of recession. Inflation fell faster than expected in September to it’s lowest since February 2010. Clear signalling that the ECB can maintain it’s loose monetary policy to aid the recovery. Consumer prices in the 17 countries nudged down to 1.1% in September, slightly below market expectations of 1.3%. The core components of E.U inflation food, alcohol and tobacco saw the highest increase, followed by services and non energy industrial goods.

Based on these results and general dovish market sentiment we expect ECB President Draghi to confirm his commitment to keep interest rates at a record low for another period. This will come on Wednesday at the ECB rate setting meeting in Paris.

We also saw the release of Greek retail sales which were down 6% .The data is a useful mirror to show the disparity with the recent data coming out of Greece. Economic sentiment and PMI is encouraging and the Greek politicians are saying all is improving. However, the streets of Athens are still reeling from last week’s riots and such a contraction in retail sales can only lead one to assume that the average Greek wallet is far skinnier than expected.

The EU and the IMF also said on Sunday afternoon that the review for the third bailout of Greece is progressing well. The Street feels sustained positive micro and macro data is still needed to ease concerns. This may be a brief upswing compared to a proper recovery.

The euro spent the majority of the day trading weaker against its major peers as political instability in Italy caused investors to shun the euro risk. Worse than expected data from China and market reports that EU unemployment is likely to remain at record highs also weighed on the currency. Unemployment for the eurozone is currently 12.5%. The OECD expects the jobless rate in the weaker nations- Greece and Spain to remain above 25% However, overnight trading saw the euro roar back against the dollar and hit a 3 month high.

Data of note out of the E.U today includes- Markit manufacturing PMI as wells as German and Italian unemployment levels.

USD

After days of discussions over the US debt ceiling the US unable to reach an agreement and partially had to shutdown at 12am ET. This is the first partial U.S government shutdown in 17 years. We expect no deal over to be reached for at least a week, or in the worst case scenario until the cash runs out which at current estimates is October 17th. This will leave the U.S government unable to meet its debt obligations. For every dollar currently printed 19 cents goes immediately towards U.S debt obligations. The debt ceiling is currently $16.699 trillion. Partial shutdown of the government will alter scheduled data releases out of the U.S. Unlikely construction data will appear at all. Non-farm payrolls release on Friday is now put in jeporday as well.

Fear is not coming from the partial shutdown but more so on what will happen if the U.S defaults on its debts as a result of being unable to agree on a new debt ceiling. The worlds largest economy defaulting on its debts would surely lead to a surrender of performance in the entire market. The ramifications would be massive, confidence and sentiment could return to near crisis levels. Capital flight out of the U.S has been heavy over the last few days with a increased flight to perceived safer currencies- CHF, GBP and YEN.

Many of the core functions of government are now shut down. Vital spending, however, will continue but discretionary spending will stop. Employees under government contract will not be paid until Congress reaches a deal. Federal employees will be staying at home unless deemed essential. It will not be immediately apparent that the Federal government has shut down. Only about 1 in 50 Americans work directly for the Federal government, excluding the military and most businesses do not sell or supply goods to the government.

Eventually though the effects of the freezing of non-essential government activity will filter into the private sector and people and business-especially small businesses which in many ways are the lifeblood of the economy will start to hurt.

We would be surprised not to see at least some movement by the end of the week, but nothing is certain and it is possible the government will remain shut down past October 17th the day the treasury estimates the cash runs out.

A continued fall in US stocks and the dollar will now continue with many of the record gains over the last quarter massively reversed. It would make little sense for investors to dive back into the US once this situation draws closer to a solution, undoubtedly the knock to confidence will remain for quite some time. The last debt ceiling crisis in September 2011 lasted for 2 weeks. The S&P 500 fell by 17% and the dollar slumped to 18-month lows. Therefore, the damage from a extended government shutdown is going to be severe. Arguably this time round it could be worse as we are still in the shadow of the crisis and it is only recently that America has started to emerge from the crisis.

The government shutdown is likely to cost at least $300 million a day from lost economic output, that is prior to counting the damage from a weaker dollar and US money market. Obama said last night failing to fund government operations- “would throw a wrench into the gears of our economy”

The wrench has been thrown the question now is how far will it travel?

The dollar has slumped to its lowest since last December against sterling and hit quarterly lows against the yen and the lowest since last May for Swiss franc. Bloomberg USD index dropped 2.8% to its lowest in 3 years.

Data releases out of U.S today- Redbook chain store sales, ISM manufacturing and construction spending.

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Written by Tom Tong

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