USD Nosedives on US Debt Mess, Aussie CPI Preview

The dollar fell hard Tuesday after lawmakers failed to make progress on raising the debt ceiling. AUD was the top performer, followed closely by EUR and GBP; NZD and CHF hit records against USD. The focus now shifts to Australia with the critical Q2 inflation report upcoming due at 13:30 GMT (14:30 BST).

US leaders spent the day hardening their positions and progress toward a deal may have even taken a step backwards. 1) Hard-line conservatives in Boehners caucus said they wont support his latest plan. 2) Some commentators noted that Obama omitted his reference to vetoing the House plan to raise the debt ceiling in his speech, saying it might mark progress toward a compromise. That wasnt the case as he reasserted that his veto intentions. 3) The White House confirmed what the market already knew Aug. 2 isnt the real deadline.

We saw several surveys about the debt ceiling and potential fallout. One from Reuters showed 30 of 53 economists saying they expect the US to lose its AAA rating from one of S&P, Moodys or Fitch.

A report by JPMorgan also highlighted the absurdity of US lawmakers arguing over $200-$300 billion in spending cuts over the next decade. They noted that a downgrade will boost Treasury yields 60-70 bps and cost the US roughly $1 trillion over the next 10 years in interest.

Economic data and markets were mixed. The Conference Board's measure of consumer confidence climbed to 59.5 in July from 57.6, beating the 56.0 consensus. The Richmond Fed hit -1 from +3 (+5 expected). Housing metrics were a mild disappointment. The S&P 500 fell 0.4% to 1332. Gold gained $8 to $1622 and silver climbed 56-cents to $40.92. Oil was virtually flat.

The US dollar fell badly across the board on Tuesday and neighbouring CAD was second-worst. Its understandable that CAD has not fully taken part in the USD rout but its somewhat surprising that USD/JPY hasnt declined more deeply. The pair hit a four-month low of 77.81 on Tuesday but if the charade in Washington continues for another 24 hours, its the odds-on favourite to break down, with stops expected below 77.75. We see very little chance of a meaningful intervention to boost USD/JPY from the Japanese government.

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Australian CPI Preview

The major release of the session comes at 0130 GMT as Australia releases Q2 CPI. The headline reading and core (trimmed mean) are both expected up 0.7%. The RBA specifically cited this release as a critical component in determining monetary policy moving forward. The market has backed off expectations from Australian rate hikes this year with the OIS market is now pricing in 42 bps of EASING in the next 12 months. It appears, however, that the RBA would be prepared to hike rates if the CPI reading is very high; i.e. above 1.0% q/q on the trimmed mean.

We think the market is pricing in a reading higher than the consensus after PPI, the import price index and Melborne Institutes inflation expectations gauge all rose above expectations. The all-time high in AUD/USD is 1.1012 and with the pair trading around 1.0950, it wont take much for a breakout.