Market Brief: Shutdown hopes bolster risk appetite

The dollar is retreating and Treasury yields are slipping as the longest shutdown in American history shows signs of coming to an end. Trading volumes look light ahead of tomorrow’s holiday, but measures of risk appetite are improving and investors are moving out of safe havens like the Japanese yen and Swiss franc into economically-sensitive units like the Aussie, Canadian dollar, and Mexican peso after a group of Democrats crossed party lines to approve a bill that would provide funding through the end of January. Uncertainties still exist: a final vote in the Senate is needed to pass the measure to the House of Representatives—where it isn’t clear that sufficient support has been established—but investors are betting that government operations could resume in the next week.

USD: Changes in cross-currency rate differentials have reasserted their dominance over the dollar’s value on foreign exchange markets in recent weeks as traders have grown more uncertain over the likelihood of a rate cut at the Federal Reserve’s December meeting. Expectations for a move surged above 65 percent last week after private-sector data showed the largest jump in layoffs in more than twenty years and the University of Michigan’s sentiment gauge slumped to a historic low. Yet alternative inflation indicators—such as the Cleveland Fed’s nowcast—suggest price pressures remain near the upper edge of the Fed’s target range, and Tuesday’s Redbook report showed retail sales up 5.7 percent year-over-year at the end of October—hardly evidence of an economy hitting stall speed. With official data unlikely to resume in the days ahead, markets will be forced to rely on guidance from policymakers themselves: at least eight Fed officials are scheduled to speak this week, ensuring traders have no shortage of noise to parse.

CAD: The Canadian dollar is pushing higher as we go to print, partly propelled by Friday’s better-than-forecast jobs data, but mostly by a broader improvement in global risk appetite. Rate differentials have narrowed in the currency’s favour on a hawkish shift in expectations for the Bank of Canada’s policy path, and oversold technical positioning suggests that the loonie could grind higher in the near term—but the operative word is “grind”, given that any moves are likely to lack conviction.

GBP: The pound is struggling to gain traction amid the broader improvement in risk appetite as traders focus on several upcoming event risks that could influence the Bank of England’s next decision. After last week’s “hawkish hold” from the central bank, odds on a December cut have settled around the 75-percent mark, and nuances in tomorrow’s labour market update, Thursday’s third-quarter gross domestic product data, and Chancellor Rachel Reeves’ budget later in the month could trigger meaningful shifts in sentiment while generating more volatility in foreign exchange markets. We think fiscal fears are overwrought, and think a stabilisation in the economy will ultimately translate into some currency outperformance, but the path there could be quite bumpy.

Bottom line: In the short term, market direction will hinge on progress toward ending the US government shutdown, but we expect this to dissipate fairly quickly once a positive outcome is priced in. With deep questions swirling around what is happening under the hood of the world’s largest economy, most market participants will avoid chasing momentum or taking large directional positions until the flow of official data resumes in the coming weeks. Volatility risks are clearly building beneath the surface, but for now, trading ranges are likely to remain tight.

Market Overview

Notes: DXY: Dollar index, ON: Overnight movement, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility,

Economic Calendar

*Likely to be delayed until government shutdown ends