The contrast between streets Wall and Main has never been more clear. Despite apocalyptic headlines in the popular media, the financial markets remain incredibly calm in the face of a potential default by the United States – Asian markets are down slightly, European bourses are trading sideways, and American equities actually increased in value over the weekend. Implied volatility levels across the currency markets are plumbing depths not seen in almost six months, and traditional safe havens like the Japanese yen have seen remarkably little buying interest.
The situation reminds us of Ronald Reagan’s quip in 1984 – “I’m not too worried about the deficit. It’s big enough to take care of itself”.
The financial markets really aren’t worried about the government’s debt problem – most participants know that it is big enough to take care of itself. Instead, they are positioning ahead of the ripple effects that a temporary government shutdown might trigger. With the economy likely to take a hit, the Federal Reserve will be under pressure to keep monetary stimulus flowing, diluting the dollar and providing emerging markets with the liquidity that they require. Given that many of the peripheral European countries are now effectively considered emerging markets, the common currency is also seeing increased buying interest.
At the opposite end of the spectrum, the Canadian dollar is facing severe headwinds. With crude oil prices and merchandise exports to the United States under threat, investors are concerned that the economy is dangerously vulnerable. Property price gains are rapidly decelerating, and overleveraged consumers aren’t able to replace foreign demand with domestic purchases.
Looking at the week ahead, these broader themes are likely to remain in place – with the debt ceiling deadline landing on the 17th (in the distant political future), the odds on a short-term compromise are very low – and diminishing. Volatility is unlikely to remain low however, given the number of datapoints that are scheduled to land in the days ahead.
For the currency markets, Wednesday’s Fed meeting minutes may have an outsized effect, given that several officials have characterized the September decision as an extremely close one. Only one committee member voted against plans to keep the taps open, but a number of non-voting regional presidents voiced concern about the policy path. In the event that the minutes articulate a more hawkish tone than investors originally believed, we could see a sharp reversal across a number of exposed pairs.
Thursday’s Chinese lending figures could also trigger sharp moves. A tightening in liquidity conditions could knock a few percentage points off the global commodity complex, while further loosening could help to materially offset the negative effects of the US shutdown. Beyond that,Friday will almost certainly create trading opportunities, with Canadian unemployment numbers, US advance sales, and the University of Michigan consumer confidence survey in the data docket, providing investors with clarity on the North American economy’s path forward.
Intelligently-placed market orders will be a valuable tool this week – potential volatility catalysts abound, while directional themes remain unclear. Talk to your trading teams about optimum trigger levels, and remember that take-profit orders should be paired with stop losses in order to protect risk thresholds.
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