FX Daily Strategist: Europe

The optimism on prospects for a quick debt ceiling deal has faded, causing equity market to decline slightly and the 10 year Teasury yield to reach its hightest level in almost a month. The impact on G10 FX has so far been subdued. While the deal framework being negotiated in the Senate is generally viewed as a step in the right direction, the prospects for this tentative agreement to make it through the House were called into doubt Tuesday with news that House Republicans were intending to pass a counter proposal of their own containing elements that have previously been rejected by Senate Democrats. Furthermore, even the Senate has not definitively agreed on the deal, and passage through that chamber could also be delayed several days if just one or two members attempt to block it. Completion of a debt ceiling agreement before the Thursday Treasury deadline appears increasingly unlikely, and market stress is likely to build further in the days ahead. Meanwhile, data on Tuesday provided the first indication that the on-going government shutdown, with the New York Fed’s Empire measure of general business conditions for October falling to a 5-month low. Ahead on Wednesday, the Fed’s Beige Book will be released and may include some anecdotal information on the shutdown’s impact on business and consumer decisions. Speaking Tuesday, Dallas Fed President Fisher, who advocated tapering at the September meeting, suggested that fiscal uncertainty now means he won’t be pushing for tapering at the October 31 meeting, suggesting the shutdown has already impacted Fed thinking. We think USDJPY is vulnerable as we head into the second half of the week without a solution. In contrast, the USD is likely to hold up better vs. the EUR and GBP, where market positioning and dovish ECB commentary are limiting gains.