Weekend political developments dominated markets at the Asian open on Monday and tended to dominate trading throughout the day.
The Italian centre-right PDL party, still controlled by former Prime Minister Berlusconi, withdrew support for Letta’s government by announcing that it would pull its ministers from office. There will be a confidence vote on Wednesday which will heighten uncertainty given a high risk of fresh elections if no new coalition can be formed and EUR/USD initially dipped below 1.35.
There was also no deal on the US budget ahead of the October 1st deadline. Republicans and Democrats continued to trade bills in Congress and there will be a partial shutdown of the Federal government if no compromise is reached on Monday. Democrats still expect the Republicans will cave-in at the last moment, but the brinkmanship could easily be miscalculated and risk appetite diminished.
Although the impact of a short shutdown would be limited, markets were also very concerned that the dispute could poison the political atmosphere badly enough to risk no agreement on raising the debt ceiling by mid October. Failure here would have a much more serious negative impact on the economy and risk conditions.
In this context, both the dollar and Euro were out of favour which benefited the yen and Swiss franc. USD/JPY dipped below the 98 level with lows near 97.50 during Monday while USD/CHF was trapped below 0.9050.
The Euro gained fresh support during US trading on speculation that divisions within the Italian PDL party could allow the Letta government to survive. EUR/USD did move to the 1.3550 area before slipping again with the dollar gaining some support from a stronger than expected Chicago PMI release of 55.7 for September from 53.0 in August. Choppy trading conditions persisted during the New York session with reports of option expiries and position adjustment ahead of the month end contributing to overall choppy trading conditions.
The latest positioning data recorded a decline in dollar long positions to a seven-month low with Euro long contracts near 70,000 and this will provide significant US protection in the short term.
The UK Hometrack house-price index registered further gains for September, maintaining optimism surrounding the housing sector, and Sterling also gained significant support from as a refuge political stresses within the US and Euro-zone with GBP/USD testing resistance above 1.6150.
Chancellor Osborne pledged to maintain a tight fiscal policy in order to bring the budget into surplus during the next parliament which had a brief negative Sterling impact on expectations of a loose monetary policy.