A sudden and surprising US dollar rally overnight was likely driven by speculation that a US debt deal will be done today, but sizable moves in EURUSD and GBPUSD would be erased if the impasse drags on.
The US dollar (USD) suddenly gained ground in mid-morning European trade today as both EURUSD and GBPUSD each plunged more than 50 points in a matter of minutes despite relatively buoyant economic data from both regions. The dollar's move higher was likely caused by growing speculation that US legislators were getting close to a compromise on the US budget and debt-ceiling deal, with the GOP expected to come together at 11 am ET today.
The Chinese have also started to impart some pressure on US government to get a deal done, with China's Vice Finance Minister Zhu Guangyan stressing that concrete steps must be taken to fend off default. The Chinese have been increasingly vocal in their criticism of the US budget negotiations, and media reports have swirled that the fiscal fiasco is getting as much attention in Beijing as it is in Washington.
The heavy-handed comments and a recent op-ed about the de-Americanization of the global economy may prove highly counterproductive, however, providing fodder for the xenophobes in the right wing of the GOP. Nevertheless, the markets are clearly trying to pressure lawmakers to take action, and today's North American session could prove quite volatile as a result.
RBA Flashes "All Clear" Sign for Now
On the economic front, the Australian dollar (AUD) was the standout overnight, and AUDUSD came within a whisker of the .9550 level after the release of the Reserve Bank of Australia (RBA) meeting minutes, which confirmed that the RBA has moved away from its easing bias.
In the latest RBA minutes, the Bank noted that there is a substantial degree of policy stimulus currently in place, and vowed to continue to gauge its effects. For now, the RBA noted that a rate cut is not imminent, but it left open the possibility for further rate cuts, if needed.
The RBA's policy stance has clearly become less dovish, as conditions in Australia have improved and markets now assign a very small chance of a rate cut in 2013. The news boosted AUDUSD, which has been bumping up against the .9500 level for several days now, and the pair could clear that barrier and rally towards the .9700 figure over the next several weeks if the debt situation in the US stabilizes and global risk appetite returns.
China Trumps Solid European Data
Meanwhile, in the UK and Eurozone, the economic news was mildly supportive, with UK CPI printing a bit higher than expected at 2.7% versus 2.5% forecast and the German ZEW survey increasing to 52.8 from 49.2 expected. However, both EURUSD and GBPUSD quickly plunged following the comments from China, which essentially trumped the positive tone of today's data.
Now, if Congress does agree on a debt deal later today, the declines in both the euro (EUR) and British pound (GBP) will likely continue, with EURUSD shorts testing the 1.3450 support and GBPUSD testing the 1.5900 level.
See also: Lesser-Known Facts About Trading the Debt Crisis
On the other hand, if little or no progress is made in the ongoing budget negotiations, flows could quickly reverse as investor fears ratchet higher and the clock keeps ticking towards the looming October 17 deadline.
By Boris Schlossberg of BK Asset Management
DailyFX provides forex news on the economic reports and political events that influence the currency market.
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Original headline: Glimmer of Home Has Dollar on the Move
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