Memory in the markets

It is now 24 hours since the ‘shock’ decision to leave QE in place.

Shock is a strong word; we would call it ‘unanticipated’.  There was plenty of data suggesting it was a possibility, particularly when you look at the unemployment data and inflation data (the two major components for the Fed’s decision).

However, market memories are short these days and we have had 24 hours of Fed bashing, having seen most investors positioning themselves for taper and getting burnt fingers. What are interesting are the comments no coming out of the Hill.

Overnight, Speaker of the House John Boehner announced that he would push ahead with a bill to defund Obamacare or shutdown the government as the US once again lurches towards the cut of date for the debt ceiling.

The Senate majority leader Harry Reid hit back, describing the bill as ‘an absurd ploy led by tea party anarchists’. With the September deadline only 10 days away, pressure is building. We clearly remember the 2011 ‘negotiations’ when the Republican party push the negotiations to within two days of the cut-off point.

This will be Obama’s third debt ceiling negotiation; the first was in 2008 when he had barely unpacked his boxes from being elected when the GFC hit and asked the house to vote on an asset rescue package to mitigate the banking crisis that was developing – it failed and the Dow crashed 10% the following day. The ceiling was lifted two weeks later, however, but by then the GFC was in full swing.

Then we move to 2011 negotiations were so tense at the time that it was famously reported that the President actually walked out of the room when discussing the bill with House of Reps leader Eric Cantor.

The final outcome of the 2011 negotiations was the ceiling was to be lifted on the condition that several very stringent (some called them draconian) tax measures were applied. However both sides agreed that these tax measures should not come into law without further debate. The taxes were known as sequester, and were to be implemented in February 2013. They had two years to debate these taxes, except no compromise was ever found and as we all know, sequester was signed into law this year.

So with ten days to go, how close to the wind will the political divide take it to this time? The Americas have $2.82 trillion in interest to be paid in 2013 and a national debt of $16.945 trillion (and growing every second), of which $855 billion goes to Medicare and $808 billion goes to social security payments. If the US was to default, over 70 million social welfare cheques would not be cashed and over 20 million public servants would go without.  This alone makes chairman Bernanke’s reasoning all the more understandable.

Market volatility will increase with every step closer to the deadline. The US markets have already latched onto the debt ceiling debate and sent the S&P and DOW back into the red after the risk on trading from yesterday. Asian markets will follow suit today.

The trick with the coming week is to look for news that a deal will be done; any news this is happening will see the US markets supported and the USD moving lower. Risk-off to risk-on will be the trade here. The closer we get to Sunday September 30, the risk on to risk off trade is the one to watch.

Ahead of the open we are calling the ASX 200 down ten points to 5285 (-0.18%). China is once again shut for the mid-autumn festival so volumes should be light. We are also watching the AUD – the RBA has also already shown its ‘frustration’ at the Fed’s decision. It looks like it will actively talk down the currency; however, where they added to the current easing cycle with another interest rate cut remains elusive.

BHP’s ADR is flat, suggesting the stock will move slightly higher, up six cents to $36.20, as iron ore stabilises. However we are aware today may see profit taking after yesterday’s gains and thus we reiterate that the clearest theme to come out of this news over the last 48 hours is upside volatility is coming in the interim, and downside volatility is now a short to medium term prospect. 

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