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European stocks gave up some weekly gains and US markets opened lower on Tuesday after US President Trump ramped up fears of a US government shutdown. Trump indicated he’d shutdown the US government by not signing off on lifting the country’s debt ceiling in order to secure funding for a border wall with Mexico.
This is signature Donald Trump. We think this is basically a bluff by Trump to get his ‘Great Wall’ back on the agenda and show some political rebellion following his foreign policy capitulation in Afghanistan. Trump wouldn’t want a government shutdown because he feels compelled to put across the image of America “winning” under his Presidency. A government shutdown symbolises failed leadership.
Stock markets displayed some signs of resurgence on Monday in a sign that the North Korea inspired August sell-off could be nearing an end. We think markets will probably call Trump’s shutdown bluff. This implies further recovery in equities so long as central bankers avoid any hawkish surprises at Jackson Hole. A US government shutdown is negative for risk so global equities would likely follow US stocks lower during the period of the shutdown, were it to occur. Were the shutdown to persist, this could catalyse some flows out of the US and into Europe as a relative haven for US political uncertainty.
Current price action in the S&P 500 resembles the lead up to the government shutdown under President Obama in 2013. The index turned lower in August but actually ended the 16-day shutdown over 3% higher. The first half of 2013 was also a very bullish period and the shutdown precipitated another rally into year-end.
The US dollar has turned lower on Tuesday on the mere chance America defaults on its debts. DXY is now testing the 93 level again. A backtracking in bets that the European Central Bank will signal the tapering of its asset purchase program has helped the greenback recover in August. A government shutdown would most likely send the dollar spiralling back down to new lows for the year. Not only would not raising the debt ceiling risk a technical default on US debts, a shutdown could bring about further ratings downgrades and erode investor belief that Trump can pass his tax cuts.
The Republican Congress has shown a desire for raising the debt ceiling but Trump’s new comments reduce the chances of a long term agreement. The most likely result is another extension, perhaps 12 months beyond the September 30 deadline.
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