FYI | Oct 09 2013
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
Rumours that the US Congress would reach a deal to extend the debt ceiling, albeit only for a few weeks, ended up being hopeless optimism, after the Republicans held a press conference with the hash tag #letstalk in the background. Maybe it would be better to resolve this whole debacle on Twitter, with only 140 characters to play with it could be solved in a much shorter period of time…
From a market perspective day 8 of the government shutdown and with only 9 days to go until the US debt ceiling will be reached means more of the same: weakness in global stocks, a weak and lacklustre dollar and gold looking comfortable above $1,300. Perhaps the yellow metal has been the biggest surprise for me – the prospect of US default has not triggered a rally in gold, even though its safe haven status and the fact it is not directly controlled by any capricious government is surely attractive in light of the political farce going on in Washington. Although last week’s dip below $1,300 attracted some buying interest, gains have been limited so far, but if there is an actual “default” on 17th October or a few days later, gold could show its colours as a safe haven.
For now the markets are mere onlookers, observing the “he said, she said” in Capitol Hill, with politicians merely pointing the finger rather than coming up with a solution. This is starting to weigh on markets, although the Treasury market is showing the most acute signs of stress so far. The 1-month Treasury yield surged to its highest level for more than 4 years earlier. Less than a month ago the 1-month yield was actually in negative territory, today it is just below 0.3%. This pace of increase is unsustainable, and the on-going stalemate could soon be felt in the Treasury’s purse as interest bills start to bite.
What is also interesting is that 1-month US Libor – the inter-bank lending rate – is a less than the 1-month Treasury bill yield, suggesting that investors see banks as more creditworthy than the government. Howe things have changed in the last 5 years! (see chart below).
Don’t forget Europe
Events in the US could be helping to disguise some potential worrisome activity in the Eurozone. Euribor rates (European inter-bank lending rates) have been rising in recent weeks, in line with the repayment of LTRO loans by Europe’s financial sector. While the repayment of these ECB loans suggest that confidence has returned to Europe’s banking sector and banks are willing to lend to each other, rising Euribor and bank lending rates could ultimately hurt the economy if it makes lending to the real economy too expensive. Also, some of Europe’s banks remain fragile, so higher overnight borrowing rates could hurt their balance sheets at some point. However, the framework for Europe’s bank stress tests scheduled for next year, said that penalty points will be given for banks that are still accessing LTRO funds. Surely this makes ECB funds more of a stigma, and if rates keep rising then the Eurozone could be on the cusp of a liquidity crunch? If the US wasn’t hogging the limelight for all of the wrong reasons then European fears could be the focus.
Bundesbank President Jens Weidmann is speaking in Berlin, he has just said that Europe’s problems are far from over and France still has problems. This could be a much-needed reality check, but it could also be a ploy by Weidmann to weaken the elevated EUR, which has backed away from 1.3600 today. If Weidmann continues in this vein then we could see 1.3580 – a resting zone from earlier, and then 1.3555 – today’s low.
Overall, the market is still second-guessing politicians, no one really believes the US politicians will not raise the debt, obviously if we are all wrong and they do that could be when the fireworks start. After the GOP’s #letstalk press conference, we don’t look any closer to a resolution.
Source: FOREX.com and Bloomberg (Prices displayed on the chart might not reflect Forex.com prices)
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