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Financial markets edge up after debt ceiling resolution

In a triumph of hope over experience, global financial markets are touching record highs this morning, lifted by a tide of optimism stemming from last week’s resolution of the debt ceiling crisis. After Congressional intransigence inflicted untold damage upon the American economy and caused the populace to turn against both parties, investors have pushed monetary tightening expectations into next year, while concluding that further brinkmanship is unlikely.

The euro and pound sterling are up sharply, while the dollar trades near lows not seen since February. Safe haven currencies like the yen and the franc are under pressure ahead of what is expected to be a strong non-farm payrolls report  tomorrow  morning, and commodities are nicely bid.

The Canadian dollar is trading near the 1.03 mark as traders position in front of Wednesday’s Bank of Canada announcement. With inflationary pressures incredibly tame, no one expects interest rates to move – but the central bank may trim its growth outlook in recognition of the impact that the US shutdown might have on Canadian exports, as well as broader economic weakness.

While these events will certainly trigger short-term volatility, the reality is that most North American data releases scheduled for the next two months have been stripped of meaning. For market participants, time is now divided into pre-shutdown, and post-shutdown eras – implying that broader themes are likely to remain intact until post-shutdown data begins to land in December.

In the absence of economic clarity, the Federal Reserve is expected to keep the monetary stimulus flowing into the new year, keeping equities, commodities, and the emerging markets well irrigated. Carry trade strategies remain well-favored, with investors borrowing in both the dollar and the euro to fund positions in higher-yield currencies.

The Canadian dollar should continue to attract inflows until distractions are removed. To borrow a phrase from Game of Thrones”¦winter is coming. The construction-related activity that supported growth earlier this year will begin to fade over the next few months, putting downward pressure on the currency. As such, we would recommend that businesses maintain a defensive posture, buying US dollars forward at incrementally lower levels, while using limit orders and currency options to sell dollars in the event that the loonie weakens below the 1.04 threshold.

Further reading:

EUR/USD Targeting Further Upside

EUR/USD Oct. 21 – Quiet Start As Markets Await US Housing Data

Karl Schamotta

Karl Schamotta

Director, FX Strategy and Structured Products at Cambridge Mercantile Group.