Overview: Investors have been shrugging off the first shutdown of the US Federal Government in seventeen years, with most asset classes and gold seeing relatively limited reaction. The calm is unlikely to last long in our view….
ETF Securities Research
Overview: The US fiscal and debt impasse continues to whipsaw markets, with gold falling below US$1,300oz last week on indications a short-term debt ceiling increase might find bipartisan agreement. While policy-makers are far from reaching an agreement, prospects of a potential temporary increase in the US debt-ceiling led to an equity market rally and lent support to the US dollar. However, with the estimated 17 October debt ceiling breach looming and no further progress over the weekend, markets are back in risk-off mode, with gold pushing higher again. Political misjudgement and resulting default (or even near default) would not just severely damage the US economy and the longer term faith in the US government’s commitment to repaying its debt, but would also have large negative reverberations across global financial markets and economies. Most investors appear to be betting that the consequences are so huge that even US politicians will eventually act rationally and find agreement. The risk, however, is that irreparable damage has already been done to investors’ long-term faith in the US’s commitment to honouring its debt obligations, further accelerating investors search for alternatives to the US dollar as a reserve asset.
Commodities: Natural gas and cocoa rally strongly on micro fundamentals. Most markets remained volatile and short-term news driven last week, with gold weighed down by reports of a potential temporary increase in the US debt-ceiling. However, natural gas and cocoa gained 6.2% and 5.6% respectively last week, driven by expected higher demand in both markets. According to the EIA, natural gas prices will average 3.77MMBtu in Q4 and 3.98MMBtu in 2014 on colder winter temperatures. Meanwhile, cocoa hit a 2-year high last week after data showed a continuing recovery in Europe’s processing volumes. Reports showing copper production in Chile will increase by 4% in 2014 compared to this year prompted a 1.5% fall in copper price. The US government shutdown, coupled with slow demand for cotton yarn kept cotton prices under pressure, with cotton closing the week down 4.9%.
Equities: European equities rise while volatility falls. Strong German industrial production data boosted the D11AX® and narrowing Italian sovereign spreads helped propel the FTSE® MIB to a two-year high. The Euro Stoxx 50® Investable Volatility Index, which provides exposure to the forward implied volatility of the Euro Stoxx 50® Index, fell back on reports that the US debt limit might be extended. In addition, ECB President Draghi’s comments that the central bank is willing to reduce interest rates should volatility in money markets rise, reassured investors that a robust framework is in place to facilitate the recovery in Europe. Lack of progress over the weekend on a resolution to the US debt ceiling stand-off, however, has boosted volatility going into this week, with US debt negotiations being watched for further guidance.
Currencies: USD in spotlight as debt limit looms. The Euro is likely to come under further downward pressure this week, with the Eurozone finance ministers meeting highlighting the on-going funding problems in the periphery. Unemployment across the peripheral states remains elevated, constraining the government’s ability to close funding gaps. Greece, in particular has indicated the need for further funds, and its reluctance to have conditions attached to any borrowings. The GBP could also come under further pressure this week if economic data disappoints, as has been the recent trend. UK retail sales could be the catalyst, as we believe that GBP is one of the more overvalued G10 currencies and it will remain particularly vulnerable to softer-than-expected economic data.
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