The political fault lines start to rupture

House majority leader John Boehner’s hold on the Republican Party is thinning as the fault lines that emerged last week start to spread to parts of the Tea Party.

- US shutdown enters seventh day

- Republicans reform fight onto debt ceiling

- Market remain unfazed

Three representatives from Texas, Colorado and Florida who are part of the Tea Party movement have now publically stated they have ‘lost the fight against Obamacare’.

The most notable of these is Dennis Ross, voted one of the most conservative members in the House (ranked by the America Conservative Union), who stated he has shifted his position because the shutdown hasn’t resulted in changes to the Affordable Care Act and that it is now hurting the Party.

‘We have lost the CR (Continuous Resolution) battle,’ Mr Ross said.

’We need to move on and take whatever we can find in the debt limit.’

It is this last line that should have the markets concerned especially when it’s coupled with statements made by John Boehner in an interview on ABC’s ‘This week’.

‘We are not going to pass a clean debt limit,’ Mr Boehner said.

’The votes are not in the House to pass a clean debt limit.’

It shows the Republicans are now moving the fight to the debt ceiling and that additional provisions are going to have to be placed on raising the debt limit before they agree.

Markets need to be aware that the impasse on Capitol Hill is far from being resolved. The US market response on Friday was on the basis that this was close to being resolved based on unconfirmed news reports out of Boehner’s office that the debt ceiling would be lifted and that President Obama was ready to reopen the government.

A major inference which the market is drawing from the media reports coming out of Washington over the week is that the debt ceiling will be passed and may even be passed before the shutdown is resolved. The shutdown stalemate continues to ebb and flow and is disruptive, but the economic impact is marginal to the whole US economy. This means monetary policy remains loose, the Chicago VIX index is raised to just shy of 17, but certainly not elevated, and it’s expected that both will be resolved without a huge amount of fuss.

It is a perfect situation for markets; money being printed and a political deadlock with a positive ‘certainty’ at the end – the muted movements in global markets are justifiable.

 When markets are this muted one thing is certain; derivatives, particularly ‘puts’, are snapped up. The ‘put’ market is currently cheap, it provides protection from any impending fall and can be traded out quickly if needed. This kind of scenario could be described as a perfect storm, as any triggering of ‘puts’ could amplify a sell off.

We expect a pop on the market today on the leads from US and the continued muted response from the markets to the debt ceiling and US government shutdown. In addition, with New South Wales, Queensland and South Australia shut for Labour Day and China still closed for its national long holiday ‘Golden Week’, volumes will be very light and the pop could be even stronger than expected. However, the sell-off tonight in the US could be strong as their markets react to the news from the weekend. Be aware we are now ten days from the deadline and no major change has actually eventuated.

Ahead of the open we are calling the ASX 200 up 26 points to 5234 (+0.5%) while BHP’s ADR is suggesting the stock will recoup some of the losses from Friday by adding ten cents to $35.23 (+0.23%), but may find buying thin with China still on holidays.

One thing is clear; the political deadlock in the US is seen as a complete distraction to the norm and this is why the markets are almost unresponsive to the issues. However, we continue to watch the T Bill due on October 24 which added another 10 basis points on Friday. The concern is very much there, it’s just a little harder to find than usual.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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