US dollar declines due to debt ceiling debacle

Expectedly, the US dollar softened on the final trading day of the week following an announcement by Treasury Secretary Jack Lew that the US government may run out of funds at some point in October if congress fails to close a deal on lifting the debt ceiling. A part of the American congress will be shut down on October 1, which is the latest date when a deal should be made in order to avoid excess volatility in the financial markets.

However, even if the US congress fails to lift the debt ceiling by then, crucial parts of it will continue work (it is only a partly shutdown), technically giving the country roughly two more weeks to find a solution. Investors should thus not buy into the fear-mongering in the financial press, even though caution is advised. Looking at the still relatively calm markets, especially compared to 2011 and the end of 2012, market participants seem to expect the US government to eventually come to an agreement before the deadline.

In addition to the budget talks, the increased uncertainty in the US stems from an ambiguous forward guidance policy of the Federal Reserve with respect to its tapering plans as well as an unfortunate search for a successor of Fed chairman Ben Bernanke.

The USD currently trades at $1.6134 against the GBP. The 0.6% gain of the British pound is not just due to the uncertainty in the United States but also because of an interview with Bank of England governor Mark Carney stating that there was little support for further quantitative easing (QE) in the UK. Cable is still about 1% below its rate from January 2013, but it has gained 6% over the past six months alone without any imminent signs of losing momentum.

The European common currency also appreciated relative to the dollar on a daily basis with EUR/USD currently trading at $1.3523. Looking at the performance over the last five trading days, this leaves the euro almost unchanged for the week. In the first half of the trading week, reports from Italy that members of the People of Freedom party were going to resign collectively if Silvio Berlusconi would be removed from the Senate caused the euro to decline. The losses have since been reversed against the dollar given the problems in the US. However, the situation in Italy still poses a serious problem, because the threat by Berlusconi's party members could well turn into a government crisis in the Southern European country. This is a risk for the European currency that may not be ignored, no matter how boring the troubles surrounding the "clown" Berlusconi may have become over the years.

Stock Markets Down on Fed Projections

Stock markets are down worldwide today after yesterday's Federal Open Market Committee (FOMC) June meeting and the release of its economic projections (PDF). The Federal Reserve projects unemployment in the U.S. to be high through the year 2013, when it should be 7 to 7.5 per cent, according to the Fed's latest estimates (this is up from last month's projections of 6.8 to 7.2 per cent). The wide range of projections even suggests the unemployment rate to be between 6.5 and 8.3 per cent (see image from the FOMC report below).

I think it's unsettling that unemployment is likely to remain that high until at least seven years after the start of the recession! Investors will be thinking the same, as suggested by international stock markets today. It certainly didn't help that Federal Reserve Chairman Ben Bernanke didn't hint at potential new steps to boost economic growth. Apparently, Mr Bernanke believes the current slowdown of economic growth to be temporary. Therefore, the central bank, which is ending its $600bn bond-buying program at this inauspicious time, will remain on hold for at least two more months before deciding about further interventions. Interestingly, the Dow Jones index temporarily jumped up yesterday right after a tweet by PIMCO's Bill Gross saying that August would likely bring first hints at QE3. However, as soon as the FOMC published its downgraded economic outlook for the US, markets turned down again.

Today's losses in Europe could also be due to profit taking after mostly good stock market performances on Tuesday. Charts below the fold. Continue reading "Stock Markets Down on Fed Projections"