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Yen Drops as US Budget Agreement Looks More Likely

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October 13, 2013 By: , No Comments

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Forex markets continue to move in a defensive mode as traders position for continued changes in sentiment.  For the first time in recent memory, most of the activity is being driven by something other than the Federal Reserve and potential reductions in quantitative easing stimulus programs.  Specifically, risk sentiment is being determined by the level of confidence with which investors believe the US government will be able to reach a budget resolution, end its temporary shutdown, and raise the debt ceiling in a way that is both fiscally prudent and meets the requirements of both opposing political parties.

Toward the end of last week, it does appear that some progress has been made on this front, as media interviews from several prominent Senators were relatively upbeat and suggestive of a potential policy agreement in coming days.  If these interviews are actually indicative of what is happening in the US government, we could start to see forex traders start to move back into higher yielding currencies, establish new carry trades, and correct some of the recent weakness we have seen in the US Dollar.

This would mean that we could easily start to see some additional upside in the Yen-denominated pairs, with a special bullish bias placed on vehicles like the AUD/JPY and USD/JPY.  If this is not the case, however, and we do see further delays in an announced budget resolution, these pairs could become particularly vulnerable to bearish volatility as investors re-position themselves.  Essentially, what this means is that we will be without a clear trending direction until markets are able to truly identify an end-point to the US government shutdown.

The Week Ahead in Forex Markets

Looking ahead to next week, most of the attention will remain centered on thebudget debates in the US.  Economic data will continue to be relegated to the “back burner” until this impasse has resolved itself.  Forex traders in short term positions will need to remain watchful of the news feeds, as we could easily see sharp spikes in volatility at any moment.  To be sure, next week’s trading activity will be best suited for those with more aggressive trading strategies but it will also be important to keep stop loss levels relatively tight in order to avoid any potential surprises.

Assuming we do see an end to the US government shutdown next week, most of the attention in forex markets will quickly return to the next set of expectations for the Federal Reserve and its plans to taper stimulus programs.  Because of this, we will see market start to be determined more by economic data (jobs figures, in particular), so once the recent event risk passes, we will see some normalization in terms of what determines the dominant trend in the US Dollar and in carry trades.  In any case, expect a week of wild volatility and the potential definition of the dominant forex trend for the last months of the year.

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