Friday, 11 October 2013

Shutdown Settlement Rumours Rally Markets As Yen Falters

Ralph Shell, Excel Analyst

With the US Government shut-down well into the second week, it is to be expected that rumors of a settlement will begin to surface.  The most recent one is a story that the government default threat will be removed by an increase in the national debt, needed to finance the next six weeks.

Naturally, this will be rejected by President Obama who wants a longer timeframe, one that will go past the 2014 election, and a 'clean' bill.  By a clean bill, they mean one without a limit on spending, or efforts to narrow the budget deficit.  Spending limits have been a difficult task for this administration.

In January 2009, when Mr. Obama became President, the national debt was $10.6T.  This week we have a crisis as the total debt becomes $16.7T.  At the rate the deficit is growing under President Obama, it will almost double the total national debt accumulated by all previous presidents.  The Republicans are trying to slow the spending, which is what the Democrats have now labeled the opposite of a clean bill.

Excel Markets ECN Forex Broker - Demo Trading Account ContestThe bickering continues, with numerous examples of government arrogance.  One interesting example is the Senate refusing to let the City of Washington D.C. have access to tax funds they have collected to run their city. 

There will likely be Washington demonstrations this weekend designed to pressure Congress and the Administration to act.  While most people blame Congress, President Obama's approval rating has fallen to 37, a new low.  Will these ratings pick up the negotiating pace?

To those unfamiliar with American politics, they appear messy, perhaps garish - they are; that is the way it was designed.  Deliberation rather than accommodation of various leaders' ideas is preferred.  Further, quick legislation in response to an emergency can often produce emotionally-driven laws du jour. 

Yes, the so-called US debt crisis is messy but at least it is being addressed, unlike the debt situation in Japan, France, Germany or many developed countries.  These three countries all have aging populations, expensive promises for retirement and health benefits and a shortage of young people paying into the social welfare kitty.  While markets may experience current discomfort, the end result could be positive.

Click to Enlarge USDJPY Daily Forex Chart

There have been reports of safe-haven buying in the yen during the past several weeks which has strengthened the yen from 100.60 to 96.60 versus the USD.  Personally, I think haven-buying in the yen is foolish.  It was more likely there was some yen short-covering which may have touched off some buying.  We do not have a current COT report but the futures OI report does show a big reduction.

Click to Enlarge USDJPY Weekly Forex Chart

Thursday, the yen lost to the USD dropping from about 97.40 to 98.20.  Rumors of a shut-down settlement might have been a partial reason, but more likely the yen was responding to comments from BOJ Governor Kuroda.  Taking a chapter from Mario Draghi, he said he will do whatever is necessary to defeat deflation.

He then continues with some tenuous assumptions.  Next year, the sales tax will go up to 8% from 5%.  This will not hurt growth because wages will then go up.  Really?

The bank will double the monetary base in the next 2 years, striving to reach 2% inflation.  August consumer prices were up 0.8% because of food and energy costs.  All nuclear plants are currently shut down so energy costs are up.

A 2% inflation rate will result in higher interest rates.  Currently, ten-year bonds yield .65%. The central bank intends to use its asset purchase plan to keep rates low.

Earlier this week, Japan's Government Pension Investment Fund, the world's largest holder of Japanese bonds, said they were going to start a new baby fund to diversify their bond risk.

In Washington, chances are the government negotiations will not go smoothly.  After all, little is ever accomplished until the last minute.  Should that be the case, I would like to use that situation to buy the USD and sell the yen on a retreat to the 97 handle.  If the talks do not go well you may suffer with the trade, but a settlement will eventually come and this should hurt the yen.
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