Grid lock in US debt ceiling talks supports Gold and CHF.
We like long EURCAD after Canada CPI surprise, and long NZD vs. USD, CAD and AUD into RBNZ.
GBP at fresh risk if Q2 GDP fails to show any growth.
The gridlock between the Republicans and democrats still evident in weekend talks leaves the timing and substance of a US deficit/debt ceiling agreement in complete abeyance. While the Democrats wish to raise the debt limit in one step to lift the threat of a default until after the November 2012 elections, the Republicans instead wish to raise it in phases. Lawmakers have set a Monday deadline to pacify markets wary of an adverse reaction should US debt be downgraded. Markets appear to be pricing in sovereign default risk with gold marking a new high and with CHF the out performer in the Asian session. How events now play out with respect to reducing or intensifying the risk of the US losing its AAA status is now absolutely key to FX in the coming week. Our sense is that even if a credible deal is struck that eliminates the debt default risk and gets the support of the ratings agencies, any support fro the dollar could prove transitory. Market may not take long to conclude that the implied fiscal headwinds in 2012 either raise the risk of the Fed enacting QE3 or at a minimum imply a commitment to a longer period of near-zero rates and no Fed balance sheet shrinkage. The US Q2 GDP print on Friday will be of some importance here, where we have a below consensus forecast of 1% (market 1.8%) and given there are as yet few signs of significant growth acceleration in Q3. This would also support our USD negative view. Under the alterative scenario of a half-baked US deficit/debt deal (or the once unthinkable scenario of a default) and which makes inevitable the loss of the US’ AAA rating, then in anything short of an extreme risk-off scenario under which US capital flies home, USD downside risks look to be substantial.
Greece’s sovereign credit rating was cut three steps by Moody’s, stating that the EU’s financing package for Greece implies substantial economic losses for private creditors. However, EU policy makers’ have exceeded market expectations with respect to the outcome of Thursday’s summit and our view is this puts a floor under the bond markets. While risks remain with regards to implementation (national parliamentary approvals, continued adherence to agreed austerity measures, etc) the road ahead looks reasonably clear for extension of the EURUSD upside. We will be refreshing our medium term forecast early this week, but as things stand as of Friday we are inclined to restate our forecasts for EURUSD rising to 1.50 in Q3 and as high as 1.55 before year end.
Outside EURUSD, we see little chance of an early let up in the pressure on USDJPY (even with a ?risk positive? US debt deal, a rally in Treasuries may pressure the pair). We see scope for further CAD weakness on crosses after Friday’s surprisingly weak CPI release, and in particular like long NZDCAD and short AUDNZD into the RBNZ?s policy decision on Thursday that may well reveal that rates hikes are close. GBP is vulnerable to any disappointment in Tuesday’s preliminary UK Q2 GDP release, which is what we indeed expect (0.0% vs. market 0.2%) especially with UK Business Secretary Vince Cable urging the BoE to consider further easing to tackle the serious problem of weak demand.
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BNP Paribas
Corporate & Investment Banking