Washington politics puts dollar in peril
Washington dysfunction is weighing on the US dollar. The federal government shutdown, which began on October 1 after Congress was unable to reach an agreement on stop-gap legislation to fund government operations, has seen the dollar fall to an eight-month low against the euro.
However, the impact could be much broader should the congressional deadlock persist, preventing an agreement on the US debt ceiling before the October 17 deadline.
The US Dollar Index, which measures the greenback’s performance against a weighted basket of G10 currencies including the euro, Japanese yen, sterling, Canadian dollar, Swedish krona and Swiss franc, had fallen to 79.63 by the third day of the shutdown, its lowest point since February.
With the shutdown exerting a substantial drag on US economic performance for every day that the government does not operate, the concern in the currency markets is that slowing growth will push back tapering further, with the prospect that US rates will not rise as quickly as expected.
Moody’s, for example, estimated that a three-week shutdown could cost the US economy 1.4% growth. Indeed, while Morgan Stanley estimates direct costs of 15 basis points of quarterly growth per day, the overall drag on the US economy could prove to be much bigger.
“The costs of the shutdown could increase exponentially with the length of the shutdown,” Morgan Stanley’s New York-based currency analysts Hans Redeker and Meena Bassily said in a recent research note.
While US economic indicators during September were relatively strong, the shutdown means that data flow from government agencies will be interrupted and several key data points will be unavailable.
For example, weekly jobless claims figures will not be available, and it is unlikely that the Labor Department will be able to publish October’s monthly employment report. The Institute for Supply Management will continue to publish its reports, with the non-manufacturing composite indicator seen falling from 58.6 to 57.0.
“The shutdown is weighing generally on the dollar via the impact on economic expectations and the consequent implications for Fed monetary policy,” says Daniel Katzive, head of FX strategy North America with BNP Paribas in New York. “If the shutdown persists, it will slow US economic activity, and the Fed’s ability to start tightening monetary policy is pushed back another quarter.
“The market was running long US dollar positions versus G10 currencies heading into September, and now ending the month with a shutdown has contributed to pressure on those positions. Going forward it seems that market positioning is now relatively flat compared to September.”
Given the lack of apparent political progress toward a compromise on Capitol Hill, the congressional stand-off presents a substantial risk to the debt-ceiling negotiation process. Indeed, efforts by House speaker John Boehner to tie government funding negotiations to an agreement on the debt ceiling have so far been met with prompt refusal by the Obama administration.
“What is clear is that the USD will stay weak as long as the US fiscal crisis drags on,” states Morgan Stanley. “Moreover, the longer it takes to come to a political agreement, the bigger the medium-term bearish USD consequences. Developments in Washington over the past week do not offer a lot of hope for a quick resolution.”
According to the Congressional Budget Office, the US Treasury will exhaust its borrowing capacity no later than October 17, leaving a cash balance of approximately $30 billion. “CBO currently projects that the Treasury will exhaust all of the borrowing authority created by those measures, as well as its cash balance, between October 22 and the end of the month,” states the agency.
While the shutdown could reduce US growth and impact Fed policy, a US government default is a grave systemic risk, which could impact the currency markets altogether more dramatically, as demonstrated in 2008. However, the market apparently continues to believe a solution to the US fiscal and debt-ceiling crisis is within reach, despite the depth of the political impasse on Capitol Hill.
“Overall, the FX price action has been pretty moderate,” says BNP’s Katzive. “The markets are currently positioned as moderately dollar negative, but we are not in a real systemic pressure environment that might be realized if we go past the debt-ceiling deadline without a resolution.”