While it is hard to expect politicians to strike a deal before the 11th hour, initial headlines from the negotiations about the fiscal cliff were positive. An early resolution of the cliff could trigger a “risk on” reaction, weakening the US dollar, at least initially, says David Rodriguez of DailyFX.
In the interview below, Rodriguez discusses the cliff, Spain, the risks for the yen, and other topics.
David Rodriguez is a quantitative analyst for DailyFX.com, specializing in statistical studies in currency trading markets and algorithmic trading systems for the Managed Accounts Programs offered by parent company, FXCM. He holds a degree in Economics from Williams College with heavy emphasis on quantitative methods and began trading financial markets in the tech boom and bust of 1999-2001. SinQuickce then, David’s primary focus has shifted from equities to currency markets, but he continues to trade futures and futures options on a broad range of asset classes as well as currencies.
- Talks about the fiscal cliff started with relatively optimistic statements. In case politicians cut a deal well ahead of the deadline, what would be the market reaction? A stronger dollar on a stronger American economy, or a risk rally resulting in a weaker dollar?
We view an early deal on the fiscal cliff as especially unlikely, as US politicians have proven time and time again that they will wait until the 11th hour to strike a deal. Early rhetoric from both sides has been encouraging, but it’s important to remember the difficult decisions at hand for both sides—this won’t come easily.
If we do in fact get a comprehensive deal well-ahead of schedule, it could prove quite bullish for global equity markets and growth-linked asset prices (i.e. “risk”). This could in fact push the US Dollar lower against risk-friendly currencies such as the Australian Dollar, but a positive outcome for the US economy means that extended declines against broader counterparts is quite unlikely.
- Superstorm Sandy is already blamed for a distortion of recent economic data, such as weekly jobless claims. Some of the next releases could be suspected as well. When would the data stop being impacted by the super-storm?
We’re going to see US economic data affected by Superstorm Sandy for some time to come. October and November economic data will obviously be the most affected. But in the ensuing months the rebuilding process in the Mid-Atlantic and Northeast regions of the United States will continue to influence key economic data releases for the US.
- With market attention being on Greece, and Spain’s reluctance to ask for a bailout, could the crisis just fade away from Spain? Or is it a dormant bomb that could explode at any moment?
Spain’s problems are almost certainly here to stay, but the clear political penalty for submitting to a bailout will keep it from requesting the bailout until it can no longer be avoided. Spain’s bond prices surged when the European Central Bank pledged unlimited bond buying for at-risk sovereigns. And though bonds have pulled back and yields are higher, current bond prices reflect the expectation that the ECB can and will step in to offset the continued crisis of confidence for Spain. That said, the problem’s clearly not going away by itself and we see little reason to expect that Spain can put off a bailout indefinitely. We wouldn’t quite characterize it as a “ticking time bomb” for the Euro Zone, but it’s certainly a considerable risk to the single currency.
- The leading candidate in Japan, LDP’s Abe, suggested that the BOJ would buy all construction bonds, reaching 200 trillion yen. Could this trigger uncontrolled inflation in Japan and a free-fall of the yen?
Political pressures on the Yen definitely represent a significant risk to JPY investors, and a clear victory by the pro-inflation, pro-asset purchase candidate in Shinzo Abe would likely produce Yen weakness. The former Prime Minister promises to raise inflation targets to 3 percent and achieve that through zero or negative interest rates as well as aggressive quantitative easing. If this comes to bear, it would almost certainly produce JPY weakness—helping explain why the Yen has already fallen to fresh lows against major counterparts. We await further details on the election and Abe’s plans, but the JPY certainly seems at risk.
- The recent inflation report by the BOE resulted in higher expectations for QE in the UK. Could more QE in the UK weigh on the pound? Or is the effect minor?
The Bank of England is a bit between a rock and a hard place. On the one hand, sluggish or non-existent growth certainly makes further quantitative easing an attractive proposition. On the other, inflation is stubbornly high and is likely to remain elevated through the foreseeable future. In effect I believe that the Bank of England may ease further, but it will likely be fairly limited in scope. There’s risk of stagflation for the UK economy—leaving the central bank in a particularly difficult position.
Written by David Rodriguez, Quantitative Strategist for DailyFX.com. Follow him on Twitter.Get the 5 most predictable currency pairs