ETP: Potential US debt ceiling breach keeps markets in thrall


Overview: Investors have been shrugging off the first shutdown of the US Federal Government in seventeen years, with most asset classes and gold seeing relatively limited reaction. The calm is unlikely to last long in our view….

ETF Securities Research

MA Weekly 14.10.13 1Overview: The US fiscal and debt impasse continues to whipsaw markets, with gold falling below US$1,300oz last week on indications a short-term debt ceiling increase might find bipartisan agreement. While policy-makers are far from reaching an agreement, prospects of a potential temporary increase in the US debt-ceiling led to an equity market rally and lent support to the US dollar. However, with the estimated 17 October debt ceiling breach looming and no further progress over the weekend, markets are back in risk-off mode, with gold pushing higher again. Political misjudgement and resulting default (or even near default) would not just severely damage the US economy and the longer term faith in the US government’s commitment to repaying its debt, but would also have large negative reverberations across global financial markets and economies. Most investors appear to be betting that the consequences are so huge that even US politicians will eventually act rationally and find agreement. The risk, however, is that irreparable damage has already been done to investors’ long-term faith in the US’s commitment to honouring its debt obligations, further accelerating investors search for alternatives to the US dollar as a reserve asset.

MA Weekly 14.10.13 2Commodities: Natural gas and cocoa rally strongly on micro fundamentals. Most markets remained volatile and short-term news driven last week, with gold weighed down by reports of a potential temporary increase in the US debt-ceiling. However, natural gas and cocoa gained 6.2% and 5.6% respectively last week, driven by expected higher demand in both markets. According to the EIA, natural gas prices will average 3.77MMBtu in Q4 and 3.98MMBtu in 2014 on colder winter temperatures. Meanwhile, cocoa hit a 2-year high last week after data showed a continuing recovery in Europe’s processing volumes. Reports showing copper production in Chile will increase by 4% in 2014 compared to this year prompted a 1.5% fall in copper price. The US government shutdown, coupled with slow demand for cotton yarn kept cotton prices under pressure, with cotton closing the week down 4.9%.

MA Weekly 14.10.13 3Equities: European equities rise while volatility falls. Strong German industrial production data boosted the D11AX® and narrowing Italian sovereign spreads helped propel the FTSE® MIB to a two-year high. The Euro Stoxx 50® Investable Volatility Index, which provides exposure to the forward implied volatility of the Euro Stoxx 50® Index, fell back on reports that the US debt limit might be extended. In addition, ECB President Draghi’s comments that the central bank is willing to reduce interest rates should volatility in money markets rise, reassured investors that a robust framework is in place to facilitate the recovery in Europe. Lack of progress over the weekend on a resolution to the US debt ceiling stand-off, however, has boosted volatility going into this week, with US debt negotiations being watched for further guidance.

Currencies: USD in spotlight as debt limit looms. The Euro is likely to come under further downward pressure this week, with the Eurozone finance ministers meeting highlighting the on-going funding problems in the periphery. Unemployment across the peripheral states remains elevated, constraining the government’s ability to close funding gaps. Greece, in particular has indicated the need for further funds, and its reluctance to have conditions attached to any borrowings. The GBP could also come under further pressure this week if economic data disappoints, as has been the recent trend. UK retail sales could be the catalyst, as we believe that GBP is one of the more overvalued G10 currencies and it will remain particularly vulnerable to softer-than-expected economic data.

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Investors have been shrugging off the first shutdown of the US Federal Government in seventeen years, with most asset classes and gold seeing relatively limited reaction. The calm is unlikely to last long in our view. Toward the end of last week there were tentative signs of increasing market impatience with the lack of progress, including continued selling of the US dollar and buying of perceived safe haven currencies such as the Japanese yen and Swiss franc. The cavalier attitude being taken by politicians about fiscal matters is leading to growing doubts about the ability of US politicians to come to a compromise that will avoid a sovereign default. With the debt limit likely to be breached around 17th October (unless extended), markets are likely to remain volatile and short term news driven over the next few weeks. In the meantime, some investors are taking the opportunity to increase positions in beaten down cyclicals. But if progress on debt negotiations maintains the current stalemate much longer, gold is likely to move back into the spotlight.


Although gold often gains during extreme events, the start of the first US Federal shutdown in seventeen years last week failed to lift the gold price. Investors appear to be looking through the storm and are focused on assets that will either benefit from the continuation of the global growth recovery or are generally uncorrelated with debt risk.  Cotton and sugar gained 2.3% and 1.8% last week, bouncing from lows hit in September, but without strong news driving the trend. Platinum and palladium fell 3.6% and 2.5% respectively. That comes despite a 17% rise in Japanese auto sales (to a 14-month high) and a 12.1% rise in UK car sales (to a five-year high). US car sales also remained brisk, despite the timing of Labor Day distorting the monthly statistics. Autocatalyts are the primary source of demand for the platinum group metals (PGMs). The strike that started two weeks ago was still on-going last week at Amplats, constraining the supply of PGMs.

    MA Weekly 07.10.13 1


US equities remain under pressure as the negotiations over raising the US debt ceiling continue. The S&P 500 fell for the second consecutive week as Republicans and Democrats continued to fight over the budget and debt ceiling. European equities have also been sensitive to the political turmoil in the US. The Euro Stoxx 50® Investable Volatility Index, which provides exposure to the forward implied volatility of the Euro Stoxx 50® Index, surged 5% last week, followed by the FTSE® MIB Super Short Strategy Index and the ShortDAX® x2 Index, up 3.5% and 1.4% respectively. Global equities are likely to remain volatile and under pressure as we get closer to the estimated 17 October hard deadline for lifting the debt ceilding.

MA Weekly 07.10.13 2


Safe haven currencies benefit as US fiscal negotiations drag on. The Japanese Yen (JPY) was the best performing G10 currency last week as investors sold risky assets and paid back JPY loans on growing concern about the lack of progress on US fiscal and debt negotiations.  For similar reasons the Swiss Franc (CHF) and even the Euro (EUR) also rallied against the US dollar last week. The British Pound (GBP) held up, continuing the trend of the past three months. However, towards the end of the week the currency showed some weakness, indicating the rally may be peaking. In our view, the GBP is one of the more overvalued G10 currencies and – despite recent rhetoric – has one of the more dovish central banks. We therefore believe the currency is particularly vulnerable to a sharp drop once growth data stop surprising to the upside.

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