How Politics Could Undermine the Dollar

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Market Drivers for September 20th, 2013
Kuroda – will keep QE expansive until inflation reaches 2%
German election this weekend not much of impact on euro
Nikkei -.16% Europe -0.15%
Oil $106/bbl
Gold $1356/oz.

Europe and Asia:
GBP UK Net Borrowing 11.5B vs. 11.9B

North America:
CAD CPI 8:30
EUR Consumer Confidence 10:00

A very muted session of trade on the last trading day of the week as currencies settled into narrow ranges and the dollar tried to recoup some of its losses after being kneecapped by the Fed. With forex markets having now digested the delay of the Fed taper, focus has turned to the upcoming political wars in Washington DC as well as the looming election in Germany.

The euro was mildly weaker ahead of the German election this week-end which still favor the re-election of Angela Merkel coalition governing majority. The German economy has performed much better than the rest of the Eurozone and conventional wisdom suggests that voters will re-elect the incumbent. However, polls ahead of the election provide little clarity as a significant part of public opinion remains undecided.

There is a small, but real chance that Ms. Merkel will not be able to achieve a governing majority with her present partners the Free Democrats. If she fails to win an outright majority Ms. Merkel may be forced to consider a grand coalition with her major opponents the center left Social Democrats led by Peer Steinbruk. Although such a super majority would have strong legislative advantage in the Bundestag the inevitable compromises in policy and prospect of governing in such unwieldy fashion could hamper Ms. Merkel ability to lead and respond quickly to key issues in the Eurozone.

Meanwhile politics is very much likely to make its presence felt in the markets on this side of the Atlantic as well. As Congress returns to work in Washington DC, the two parties show no willingness to compromise on the key issues of budget deficit and debt ceiling limits. With GOP sensing that President Obama has been weakened by his handling of the Syria crisis, their intransigence may only harden as the days go by, with the possibility that US could face another government shutdown.

Such a course of events if it were to occur would no doubt be a major destabilizing factor for financial markets as infighting in DC could lead to volatility on Wall Street. For now the dollar has stabilized at current levels and tonights lackluster action suggests that it may even rally a bit as some short covering price action takes place. However, if developments over the next few weeks begin to suggest that the political battle in DC shows no signs of resolution the greenback could weaken again as currency markets begin to fear the never ending supply of QE from the Fed.

Boris Schlossberg
Managing Director

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