The Debt Ceiling and QE3

Our base case is for a bounce in stocks and USD after a debt ceiling deal is reached. We see a 90% probability of a deal before markets open on Monday and we will continue to trade in that direction.

Our trades were working for us until late in the session Thursday when sentiment worsened after S&P sovereign-rating chief John Chambers re-emphasized the importance of $4 trillion in savings. Both parties are currently proposing less than $3 trillion in savings so it looks more likely that S&P will have courage to cut.

Republicans postponed a vote on Boehner’s debt ceiling plan minutes before it was scheduled, likely because they did not have the votes in their own caucus to pass it. In any case, the legislation had no chance of getting by the Senate or the White House, so the delay could be helpful for negotiations. A vote is expected later in the evening but it is unlikely to move markets.

VP Biden is said to be in talks with Senate Republican leader Mitch McConnell on a deal. McConnell earlier said THE ONLY REAL STICKING POINT between the two sides is a Republican insistence on a two-stage ceiling increase process. We see this as a good sign for our USD/JPY and USD/CHF longs. There are also reports that a short-term debt limit extension may be possible if no agreement can be reached.

The QE3 debate will re-ignite after the debt ceiling and downgrade drama passes. The Fed’s Lacker (voter in 2012) called the US recovery decidedly mediocre but said the factors that have held growth back are beyond the Fed’s control – a signal that he will not support further QE. He said the US doesn’t face a significant risk of growth below 2.75% in the next two years.

Separately, the Fed’s Williams (voter in 2012) said the Fed may need to increase stimulus but that there is a “high hurdle” before he will consider it.

A broad slate of economic data from Japan will be released at 2330 GMT including CPI, employment and household spending. Industrial production will follow 20 minutes later. All the data is for June. It’s difficult to strategize around these numbers because of potential skews from the disaster but overall we expect a straightforward reaction with JPY strength on upbeat growth numbers.

Share