Dollar Bounces, RBNZ Holds Rates

Markets soured Wednesday on the debt ceiling stalemate, poor economic data and the threat of a downgrade. Broad risk aversion hurt EUR and CAD while AUD and USD were top performers. The RBNZ held rates but hinted at a 50 bps hike in the near future.

The S&P 500 fell 2% to 1305 and is the process of putting in its worst weekly performance in almost a year.

According to the Beige Book, the pace of economic growth has moderated in 8 of 12 districts and that the pace of the recovery has slowed a line you will probably see in the upcoming FOMC statement. The jobs market remains discouraging. Input prices also moderated, meaning QE3 is more likely than the removal of any monetary stimulus. The report points to continued slow economic growth but no recession.

Durable goods orders tumbled 2.1% in June compared to the +0.3% expected. Non-defense capital goods ex-air fell 0.4% compared the +1.0% expected. The numbers point to the risk of a downside surprise in Fridays US GDP figures (exp: +1.7%).

Ashrafs USD/JPY short hit preliminary targets and fell to within 7 pips of the ultimate target. Gold hit initial targets before pulling back. Crude is resting just shy of the initial target.See the latest at: http://ashraflaidi.com/products/sub0/access/?a=462 NON-SUBSCRIBERS: http://ashraflaidi.com/products/sub01/

Not long ago, Geithner was pronouncing the US would never lose its top rating but now the market is in the process of pricing in a downgrade. The consensus is that the US dollar will continue to fall but it may not be as straight-forward as advertised (as we saw today). A continued decline in the stock market will provide a safe-haven boost to the USD as will higher bond yields. The resulting slowdown in the US economy may also weigh more heavily on Canada with risks to the other commodity producers and the economies most tied to US consumption.

At the moment, the situation is looking dire but whats has been lost is that DEBT CEILING NEGOTIATIONS ARE MAKING PROGRESS. Boehner is reworking his proposal and appears to have his own party on board. Reid is also looking for additional cuts in order to satisfy the dollar-for-dollar demands from Republicans. The sides now dont appear all that far apart and we estimate a 75% probability that will we have the framework for an agreement before markets close on Friday.

This will present the opportunity for a significant relief rally in the time between the passage of the legislation and decisions about the credit rating. Theres also the distinct possibility that the ratings agencies dont have the courage to downgrade the US. Based on this, there is room for a bounce in USD/CHF and USD/JPY -- both may have stabilized and at oversold levels.

THE RBNZ HELD RATES AT 2.50% as expected and Bollard said the economy grew more strongly than expected. The central bank leader telegraphed an upcoming rate hike by saying there is little need for the 50 bps March insurance rate cut to remain much longer. The market has priced in 100 bps in hikes in the next 12 months but nothing beyond 50 bps is guaranteed. Bollard may have done a good job talking down NZD by nothing that if the currencys strength persists, it will reduce the need for rate hikes.