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No sooner had the Federal Reserve decided to maintain the pace of its quantitative easing programme that a new worry loomed in the forex markets and this time it is over the negotiations to raise the US debt ceiling – a process that should be supportive for USD.

The political landscape is shifting towards a period of uncertainty, which is usually USD bullish and implies pressure on risk currencies such as AUD, GBP and emerging market ones.   The Fed deciding to carry on creating new money at the same pace as before briefly bid up risk markets. But on reflection it was yet another piece of poor communication from the Fed as the markets were ready and primed for tapering.

By Justin Pugsley, Markets Analyst MahiFX Follow MahiFX on  twitter

But for now there is something more important for the forex markets to ponder. The US is repeating a strange political ritual that spreads deep fear in the markets. It’s the negotiations for extending the US debt ceiling, which allows government to keep borrowing more money so it can pay its bills.

Volatile politics will drive EUR/USD for next month or so

EURUSD Technical view debt ceiling budget debacle September October 2013

Acrimony will intensify uncertainty

The debt ceiling negotiations will be deeply acrimonious reflecting the profound divides of opinion within US politics. The result will be steadily increasing levels of uncertainty as various parties refuse to budge on their positions leading to the very real possibility of a US government default – a potentially catastrophic outcome for the global economy.

It is estimated that the debt ceiling will be hit around mid-October and no doubt, as on previous occasions, a deal will be struck at the last minute. If a deal is agreed, which removes uncertainty, then a rally in risk currencies and the stock market is likely to follow, and the Fed may well decide to start its long-anticipated tapering.

In the meantime, Forex markets are likely to study next week’s non-farm payrolls numbers in that context. It is worth noting that recent numbers, though showing improvements, have been disappointing. Another below expectations number may see the Fed hold back on tapering, even if the US budget negotiations are eventually successful.

Yet another political focus for the forex market is the election victory of Chancellor Angela Merkel in Germany, which has strengthened her position. The main task now will be to form a political coalition, which may take up to a few weeks. Once that’s done the markets may well home in on the economic problems festering in the Eurozone’s periphery and the lack of progress in building a banking union – another source of uncertainty, which if realised would also be USD positive.

Further reading:  Time for the US dollar to recover?