Not long ago, Geithner was pronouncing the US would never lose its top rating but now the market is in the process of pricing in a downgrade. The S&P 500 fell 2% to 1305 on Wednesday and is the process of putting in its worst weekly performance in almost a year. The consensus is that the US dollar will continue to fall but it may not be as straight-forward as advertised. A continued decline in the stock market will provide a safe-haven boost to the USD as will higher bond yields. The resulting slowdown in the US economy may also weigh more heavily on Canada with risks to the other commodity producers and the economies most tied to US consumption.
At the moment, the situation is looking dire but what’s has been lost is that DEBT CEILING NEGOTIATIONS ARE MAKING PROGRESS. Boehner is reworking his proposal and appears to have his own party on board. Reid is also looking for additional cuts in order to satisfy the dollar-for-dollar demands from Republicans. The sides now don’t appear all that far apart and we estimate a 75% probability that will we have the framework for an agreement before markets close on Friday.
This will present the opportunity for a significant relief rally in the time between the passage of the legislation and decisions about the credit rating. There’s also the distinct possibility that the ratings agencies don’t have the courage to downgrade the US. Based on this, there is room for a bounce in USD/CHF and USD/JPY — both may have stabilized and at oversold levels.
We will enter longs in both these trades ASAP. Follow @FX_Button on Twitter for live updates
THE RBNZ HELD RATES AT 2.50% as expected and Bollard said the economy grew more strongly than expected. The central bank leader telegraphed an upcoming rate hike by saying there is little need for the 50 bps March “insurance” rate cut to remain “much longer”. The market has priced in 100 bps in hikes in the next 12 months but nothing beyond 50 bps is guaranteed. Bollard may have done a good job talking down NZD by nothing that if the currency’s strength persists, it will reduce the need for rate hikes.