Fiscal Cliff Negotiations Drag Risk FX Down

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Market Drivers December 31, 2102
Senate fails to take vote on Fiscal Cliff, resumes 11 AM EST
Chinese PMI hits highest read since May 2011
Nikkei closed, Europe -0.03%
Oil $90/bbl
Gold $1669/oz.

Europe and Asia:
AUD Private Sector Credit 0.0% vs. 0.3%
CNY HSBC Final Manufacturing PMI 51.5 vs. 50.9

North America:
USD Senate resumes Fiscal Cliff deliberations 11:00 EST

As expected currency markets were generally quiet on the final trading day of the year with Japan closed for holidays and most of European bourses operating shortened hours on New Year’s eve. The tone however was to the downside as negotiations on the Fiscal Cliff continued to stall last night with Senate not taking a vote on the matter. Lawmakers convene again at 11:00 am EST to see if they can iron out a last minute compromise and avoid the prospect of higher taxes and instant spending cuts via sequestration.

The EUR/USD drifted lower in very thin trade dropping to 1.3178 before rebounding slightly as investors grew increasingly concerned that US lawmakers would fail to reach a compromise on the Fiscal Cliff issue. The paralysis in Washington is already taking its toll on business and consumer sentiment in the US and if the issue goes unsolved into the New Year the slowdown in US economic activity could be palpable.

The optimists who argue that even if nothing will be done today, the issue will be dealt with when the new Congress convenes fail to realize that the loss of momentum from even a few weeks of delay could have a marked impact on Q1 GDP as US businesses remain paralyzed awaiting a decision.

Meanwhile elsewhere, the news was more constructive. December HSBC China Manufacturing PMI came in at 51.5, vs. 50.5 in November and 50.9 for the flash December 14 reading. The 51.5 print was the highest since May of 2011 while the New Orders sub-index was 52.9- the best in nearly 12 months. The news out of China appears to confirm that the manufacturing sector has managed to achieve a soft landing and is now once again in growth territory. However, the Chinese manufacturing recovery remains fragile with export orders down slightly to 49.2 and could very vulnerable to any slowdown in US demand if the Fiscal Cliff negotiations drag on.

With US equity markets open for a full day of trade and Senate proceedings starting at 11:00 AM EST, the focus fall squarely on Washington DC for the whole day. There remains some optimism that lawmakers could come to terms on a “mini-deal” that would extend the debt ceiling deadline and avert the automatic tax hikes. Some analysts argue that the true deadline could be extended to January 7th which would make it relatively easy to backdate any legislation to the start of the year, however if the day’s proceedings produce no resolution the sell off in risk is likely to accelerate and EUR/USD could quickly drop below 1.3150 as trading closes for the year.

Boris Schlossberg
Managing Director

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