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Euro, US Dollar Drop versus Japanese Yen amid Political Déjà Vu

Euro, US Dollar Drop versus Japanese Yen amid Political Déjà Vu

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- US government to shutdown as Congress fails…again.

- Italian government under pressure – vote of confidence on Wednesday.

- Complacency in markets – bonds, commodities, equities, and FX – likely finished.

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(vs USD)








Dow Jones FXCM Dollar Index (Ticker: USDOLLAR): -0.09% (-0.15%prior 5-days)


Signs of investors uncertainty amid heightened sovereign credit risk are starting to emerge, as political tensions in the United States and Italy – two of the world’s largest debt markets – have officially boiled over. An increasingly partisan US Congress has pushed the world’s largest economy to the verge of a government shutdown, and perhaps a default on its credit in a few weeks, while Italian political titan Silvio Berlusconi’s declining popularity threatens the stability of the government.

No, this isn’t a summary of events in the summer/fall of 2011. It’s 2013, and we’re witnessing political déjà vu. In the United States, Republicans have decided to leverage the government’s credit worthiness for policy changes, which are highly unlikely to be conceded by Democrats – why would President Obama strike down his own legislative advancements? – making a government shutdown at the start of October all but guaranteed. The debt ceiling debate looms large as the country could default in a few short weeks.

In Italy, it is not Mr. Berlusconi who is losing power but instead he is threatening to take away power, as his Centre-Right party has abandoned the coalition under Centre-Left Prime Minister Enrico Letta. As the issue is quite entangled – the Italian Senate will vote in the coming days on whether or not to ban Mr. Berlusconi from politics – a vote of confidence for the Italian government will now take place to see if new elections are necessary.

As was the case in those rocky months of mid-2011, the Japanese Yen has emerged as a top performer (as has the Swiss Franc) as both the Euro and the US Dollar have suffered. Sovereign CDS contracts (essentially insurance on debt) have widened out suggesting that investors are bracing for impact. Yet FX markets haven’t toppled: the commodity currency bloc (AUD, CAD, NZD) remain buoyant. Accordingly, complacency remains; though once the US government shuts down on Tuesday, the tone should change dramatically.

EURJPY 5-minute Chart: September 30, 2013 Intraday

Euro_US_Dollar_Drop_versus_Japanese_Yen_amid_Political_Deja_Vu_body_x0000_i1027.png, Euro, US Dollar Drop versus Japanese Yen amid Political Déjà Vu

Taking a look at European credit, rising Italian political tensions have levied pressure on sovereign debt, presenting a sustainable drag on the Euro for the next several sessions. The Italian 2-year note yield has increased to 1.936% (+6.4-bps) while the Spanish 2-year note yield has increased to 1.546% (+1.5-bps). Similarly, the Italian 10-year note yield has increased to 4.488% (+7.6-bps) while the Spanish 10-year note yield has increased to 4.355% (+0.2-bps); higher yields imply lower prices.

Read more: Making Sense of the Fed’s Non-Taper – We Should Have Seen it Coming


Euro_US_Dollar_Drop_versus_Japanese_Yen_amid_Political_Deja_Vu_body_Picture_1.png, Euro, US Dollar Drop versus Japanese Yen amid Political Déjà Vu

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--- Written by Christopher Vecchio, Currency Analyst

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