Risk FX Dives as US Inches Towards the Fiscal Cliff

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Market Drivers Dec. 21, 2012
Boehner cancels vote on Plan B sends risk lower in Asia
UK GDP 0.9% vs. 1.0%
Nikkei -0.99% Europe -0.53%
Oil $89/bbl
Gold $1650/oz.

Europe and Asia:
NZD Credit Card Spending 3.9% vs. -0.9%
EUR German GfK Consumer Confidence Survey 5.6 vs. 5.9
GBP Public Finances
GBP Public Sector Net Borrowing

North America:
USD Personal Income 8:30
USD Personal Spending 8:30
USD Personal Consumption Expenditure Core 8:30
USD U of Mich Confidence 9:55
CAD GDP 8:30
CAD CPI 8:30

A very volatile night of trade in the FX market as the failure of John Boehner to bring his “Plan B” to vote in the House or Representatives sent risk assets tumbling on fears that a deal on the Fiscal Cliff will not get done before the year end. The House now closes for a break and will not reconvene until December 27th leaving little room for US policymakers to enact a compromise before the automatic sequestration cuts begin to take effect.

The best case scenario assumes that Mitch Mcconnell will not block Harry Reid in the Senate and will allow the most recent offer from President Obama to reach the floor. Democrats need only 26 GOP votes to pass the bill and avoid the Fiscal Cliff consequences.

The markets however are becoming extremely nervous as time is running out for any compromise solution and that fear took its toll in Asian session trade as EUR/USD tumbled below the 1.3200 level and USD/JPY dropped below 84.00 in reaction to the news. The EUR/USD however has managed to hold its near term lows at 1.3185 as the investors continue to give the benefit of the doubt to US policymakers.

Today’s quadruple witching expiration in US markets along with holiday thinned trade could create further volatility when the markets open in North America. Furthermore any fresh headlines from DC will likely add to the turmoil and we could see a rollercoaster session as policymakers scramble for a solution.

Meanwhile the eco data has been all but ignored as macro considerations take center stage. In Europe the GFK consumer confidence numbers printed worse than expected at 5.6 versus 5.8 eyed and in UK the GDP was revised to 0.9% from 1.0%. But traders focused only on the Fiscal Cliff story and it will doubt dominate trade for the rest of the day as its implications are global.

The greatest fear amongst investors is that the sudden shock to US aggregate demand caused by the automatic sequestration of government spending and the simultaneous hike in taxes could have a chilling effect on global growth stifling any chance for a possible recovery in Europe and slowing growth in Asia.

Yet despite the cataclysmic predictions, the price action in FX continues to reflect a general attitude of complacency. If the markets are correct and a deal is somehow consummated, the relief rally in risk could take EUR/USD through 1.3300 and beyond. However, if the prospect of failure becomes more real, the recent support 1.3185 will collapse and the pair could trade to 1.3000 before end of the year as markets make adjustments.

Boris Schlossberg
Managing Director

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