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Although markets had been fairly optimistic a deal in Washington would get done before the “x-date” of October the 17th, risk sentiment got a fresh boost yesterday afternoon when it finally became apparent that Republicans had reached their breaking point and could no longer delay the raising of the debt ceiling and funding of the government.   House Speaker John Boehner confirmed that the bipartisan agreement drawn up by Senate leaders Reid and McConnell (a deal that barely touches on concession to the Affordable Care Act) would be allowed to make it to the floor, and pass with Democrat votes, marking a significant concession for the speaker as the Republicans switch tactics and end this chapter of the fiscal battle.

The S&P rallied on the news and held its gains into the close, finishing higher by 1.38% while cash VIX fell almost 4 vols to settle just below 15%, as traders and investors un-wound short-term protection.   The improved risk sentiment was also seen in US treasuries, with the short-end of the curve well bid as liquidity rushed back into the one-month note; yields dropped over 50% from where they opened, ending the day at 0.145%.

As expected, the deal is nothing more than a temporary “Band-Aid” solution, funding the government through January 15th  and lifting the debt ceiling through February 7th.   While the deal alleviates the short-term anxiety around a technical default, it is very possible we could be back in the same position in a few months if Washington is once again paralyzed by lack of negotiation due to political gridlock along party lines.   The Loonie found some strong buying interest on the relief rally as protective hedges were lifted, which pushed USDCAD through trend-line support into the low 1.03s.

Looking at market action overseas, equities are exhibiting some weight to the tape as the major bourses trade slightly lower midway through the European session.   There was further bright data for the UK economy released earlier this morning, showing that retail sales rose by more than forecast over the month of September, coming in with a y/o/y increase of 2.2%.   The strength in consumer spending coupled with yesterday’s labour statistics confirms the economy is strengthening, possibly on firmer ground than the Bank of England had expected.   Another strong domestic data print has the pound rising again this morning, trying to move north of the 1.6100 level against the USD.   Despite the jubilant price action in Cable, the FTSE is lower by 0.12%, echoing the muted price action in equities as the Dax and Stoxx are also lower by 0.53% and 0.47% respectively.

Moving on to the North American open, equity futures are displaying classic “buy the rumor, sell the fact” behaviour as price action remains subdued before the opening bell.   Also weighing on markets slightly is the fact that we could be revisiting the same dog and pony show in a few months, so it will be interesting to see how the VIX futures curve performs today, and if traders now look to bid up protection in the belly of curve around January and February.

The resolution in Washington is also starting to flow through to FX markets, with participants now keen to focus on what the fallout from the last two weeks means for the Fed taper timeline.   We still hold our forecast that a taper from the Fed won’t come until Q1 2014, and with other participants now pushing back their expectations, the dollar index is under pressure this morning with the DXY falling back beneath the 80 level.   The EUR is up over a big figure against the USD as the pair moves into the mid-1.36s, while we are also seeing USD weakness push USDJPY south of the 98 level this morning.   The fall for USDCAD through the bottom of the upward trend channel that had been in place since mid-September increases the likelihood momentum continues to push the pair lower, with the mid-102s and the 200 day moving average the next target in sight.   As mentioned previously, the spread between USDCAD spot and implied vol in the options market is compressing, with a potential for further compression should realized vol continue sinking.

In terms of economic data this morning, the releases were fairly mundane relative to the deal that was just brokered in Washington. Jobless claims for the American economy came in slightly higher than expected at 358k, but still down from the 373k the week prior.   This release is likely to be volatile over the next couple of weeks, as the statistics will be hard to estimate considering there is no way to break out the government works applying for unemployment benefits.

At the same time, data was released that showed foreigners picked up $2.1bn Canadian securities over the month of August, down from the $6.1bn that had been added in July.   The soft release was somewhat expected, as the prospects for a Fed taper in early September most likely kept investors shying away from debt instruments in growth-heavy countries and emerging markets.   The Loonie took a bit of a hit after the release, but we don’t expect the release to be more than a knee-jerk reaction.

Now that near-term concerns over a default in the United States have eased, there are a few important economic releases on the docket that could influence price action for the Loonie heading into the end of the week.   Q3 GDP figures for China are due to be released this evening, and after the less than inspiring economic data last weekend, analysts are still expecting that growth picked up to an annualized rate of 7.8% in the third quarter, slightly faster than the 7.5% registered in Q2.   Well there are nagging concerns that softer export numbers and sluggish electricity consumption at the end of the quarter could weigh on the release, a number that meets or exceeds forecasts will bode well for risk appetite and growth-related currencies like the Loonie, confirming growth in the region is above the 7.5% floor Chinese officials are looking to achieve.   A release that comes in south of the median forecast of 7.8% will dampen the outlook for global growth, leaving investors skeptical of the tools Chinese policymakers will be able to implement in order to stimulate growth in the region.

On the domestic side of things, consumer pricing data for the Canadian economy is set to hit the wires  Friday  morning, with expectations for the headline reading to remain unchanged at 1.0% on an annualized basis.   The Ivey PMI reading for September showed that prices increased at a faster pace than August, so it will be interesting to see if the survey from purchasing managers flows through on the consumer side of things, or if demand is still not robust enough for corporations to risk hiking prices on end users.   A warmer than expected reading could add more fuel to the Loonie buying fire, as the recent inflation readings in Canada have shown little upward pressure on prices, pushing the possibility of an impending rate hike in Canada further into the future.

The combination of Chinese GDP data and Canadian inflation numbers could make for some volatile price action into the end of the week, so make sure to speak with your dealing teams in regards to implementing strategies to harness the potential volatility surrounding the releases.

Further reading:

US jobless claims remain high at 358K

EUR/USD breaks resistance – at 8 month high