No Jobs - EUR to 'Diddle-For-Middle'

by: Dean Popplewell

Worries about the U.S. debt ceiling are beginning to filter through and unnerve investors as we commence day-four of the partial U.S. government shutdown. Asian and euro markets have thus far been rather resilient to the shutdown – believing that a solution was close at hand. However, it seems not so, and even the traditional risk aversion strategies are at odds to what investors would normally be doing in times of uncertainty and event risk. Today, markets will have little to trade off – the release of the “granddaddy” of economic indicators non-farm payrolls has been postponed due to various federal agency closures.

A mystery to many is the price of gold. Traditionally, the commodity of choice to the market as a safe haven investment in times of strife, however, its recent price action – trading flat again overnight – is in contrast to regular trading patterns during an event risk. What is currently underway in Washington should have caused more of a rally for prices in the metal. The commodity seems to have decoupled from unknown events and their outcomes. Maybe the “yellow metals” performance suggests that this shutdown is not going to go on for too much longer?

Perhaps the market is incorrect and the EUR bull should be worried with current price levels? The forex market is definitely favoring being long the 17-member single currency, and while investors remain content with the trade further upside from current levels may be a struggle (1.3609). “Diddling-in-the-middle” and trading close to year-highs suggests that the most vulnerable side could still be the EUR’s left-hand side. The technicals would suggest that failing to trade through resistance at 1.3625-30 with gusto opens up the opportunity to retest levels well below, around 1.3570. A break through here would be the first real warning signal that the uptrend may be coming to an end. Do not be surprised to see many bulls raising their stop levels before the weekend. This action will however end up being a strong magnet.

This partial U.S. government shutdown has been pushing investors to pare back their yen short positions (¥97.09). The first to be cut were those used to fund the “carry” trade. This current trading environment is not one that is outwardly supporting riskier-trades. With this week's price action, the massive speculative short yen position has been Prime Minister’s Abe’s biggest obstacle to a weaker yen currency. Basically, too many investors have the same trade on. Although, with this week’s U.S. problems, those positions must have been significantly adjusted – despite the fundamental reason for being long USD/JPY having not changed. Analysts note that if “the yen-funded carry trades have been washed out, perhaps uncertainty over the U.S. may have little impact on the JPY in the short-term.” If risk aversion were to grow from here there would only be one winner and that is the dollar.

What effect is this U.S. shutdown to have on the Fed’s timetable to taper stimulus? San Francisco Fed head Williams said yesterday that tapering plans remain on track and that policy makers had their own set of data sources that remain available. Where is the transparency in that? Capital markets are most likely taking the opposite view, they seem less certain that this U.S. shutdown will not be pushing tapering further out. Once growth becomes affected, more stimuli will be required as the U.S. growth rate is precarious at best. Investors will end up taking their cue from the best “can kickers down the road” – the Fed itself. Further stimulus will favor riskier assets and high-beta currencies. However, no progress being made with the U.S. fiscal negotiations does not favor owning the dollar.

In three months GBP has risen 10% – rallying from its yearly lows to this year's high this week (1.6260). The market is somewhat confused by its strength. Everyone believing in a less dovish Fed and a stronger U.S. economy would be leaning towards a pro-dollar. However, strong data continues to support sterling. Next week the BoE is expected to leave interest rates and QE on hold. The initial impact on GBP should be minimal and the same for U.K. market yields. Governor Carney and the market are beginning to meet halfway and merge their views. Carney is starting to revise “up the economy’s growth expectations,” while the market is beginning to price in “no rate changes” for longer. If anything, front end gilt yields should soften, causing sterling to become less attractive in the medium term.

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