US debt ceiling returns into focus

Dear beggars, brace yourselves for the return of the ugly US DEBT CEILING! Yes, it's true. Following the momentary suspension of the debt limit in October 2013, the debt ceiling is back in focus as we quickly approach the end of the suspension on 7 February 2014. Although most analysts expect the debt ceiling to be raised before the US Treasury manages to exhaust the limit, which Treasury Secretary Jack Lew says would be at the end of February, investors should consider that this issue is likely to weigh on the US dollar this month. For traders, this may well be an opportunity to enter speculative USD shorts with tight stops and an investment horizon of up to a month, given that February may see increased volatility in USD exchange rates.

For example, we just posted USDTRY short as a high-risk trade idea in light of this issue and the fact that the problems surrounding Turkey have began to cool down following the Turkish central bank's interest rate increase. If you want to stay clear of EM exposure, there is always EURUSD long, but this should only be a short-term trade as we still expect the euro to depreciate versus the dollar in 2014.

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.

US government shutdown looms... again

Once again, the US government faces a possible shutdown as it has so far been unable to agree on a higher debt ceiling. US Treasury secretary Jack Lew told Bloomberg that the United States only had about $50bn left and could run out of funds as early as October 17, if no deal will be reached. Given the still uncertain state of the American and the world economy, it is careless that the Democrats and Republicans persist on their positions and are unwilling to compromise. Ideally, they would realize that they're an elected government that must respond to potential threats, such as the inability to pay the nation's bills. In reality, each party is constantly looking for ways to make the other one look bad.

International stock markets have reacted accordingly by moving funds to perceived safe havens, such as gold. Stocks slipped and the USD softened slightly, as measured by the dollar index. Unlike in 2011, there were no extreme price moves, however, as the market still expects the government to reach a deal by October. This is one of those low probability events bulls do not want to happen, so investors are advised to watch the US government's progress (or lack thereof) closely. A deal must be reached by October 1.

The EUR/USD rate is currently at $1.3493, approximately 2.2% above its level from the beginning of the year and more than 5% above the level from mid-July. GBP/USD is at $1.6020.