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The "Hostage" Situation Involving the Dollar

The "Hostage" Situation Involving the Dollar

Kathy Lien, Technical Strategist

With the clock ticking on the debt ceiling debate and a potential government shutdown looming just days away, the US dollar and broader economy are being held “hostage” by all the uncertainty.

With only five days to go before a potential shutdown of the US government, the clock is ticking and investors are getting nervous. The US Senate is scheduled to vote on an emergency spending bill to finance the government today, and the bill that includes the controversial health care law will then be passed to the House, which meets over the weekend.

House Republicans have vowed to change any bill that includes funding for Obamacare, and will undoubtedly insert changes aimed at killing the plan. They will then pass the bill back to the Senate, which will have only one day to act before the October 1 deadline.

As this deadline approaches, investors are stepping up their sale of the US dollar (USD) due to growing concerns that a government shutdown will undermine the quality of US assets and lead to a retrenchment in US growth. Today, the dollar is trading lower against all major currencies except for the Australian dollar (AUD) and New Zealand dollar (NZD).

Ratings agency Moody's estimates that a three- to four-week government shutdown could shave as much as 1.4% off of US growth, but this forecast may be overly pessimistic considering that a two-week shutdown is expected to cut growth by only 0.3% - 0.5%.

We are still hoping for an eleventh-hour deal, but the prospects for that are growing dimmer by the hour, and in the meantime, Congress holds the US economy and the dollar hostage.

More Resounding Negatives for the Dollar

A number of Federal Reserve officials have already spoken this week, but most have been non-voting members of the Federal Open Market Committee (FOMC). Today, however, all three Fed Presidents scheduled to speak are FOMC voters, and therefore, the markets will be particularly sensitive to their comments. Considering that Charles Evans (Chicago), Eric Rosengren (Boston), and William Dudley (New York) are all known doves, we expect their comments to be negative for the dollar.

Unfortunately, this morning's economic reports failed to help the greenback. Personal income growth accelerated to 0.4% from 0.2%, but the increase was still less than expected. Personal spending, on the other hand, rose to 0.3% from 0.2%. These reports did not deviate from expectations by much, and as a result, they produced very little reaction in the greenback.

The final revision to the University of Michigan consumer sentiment report was also released this morning, and while economists were looking for an upward revision, a small decline was reported.

Until the debt ceiling is raised or the fiscal showdown is postponed for a few months, we expect the dollar to remain under pressure. A lot or very little could happen over the next five days, but we hope the consequences of holding the economy hostage are not lost among politicians and they will agree to a last-minute deal that would potentially drive a relief rally in the dollar.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.