The theme of the day is once again sell the dollar. Weakness in the greenback has been broad-based this morning and the dollar index is down nearly 1 per cent.

The biggest moves have been versus the safe havens. USDSJPY fell to below 0.8000 versus the Swiss franc, and below 78.00 versus the yen. Gold has been trading sideways above $1,614/5, while silver maintains its upward momentum. The commodity sphere should do well when the dollar is this weak, and Brent crude is trading at $118 per barrel.

The dollar is being weighed down by politics. In a speech last night President Obama effectively blamed Republicans for the stand-off on the debt ceiling, which was met by a strongly-worded reproach from Republicans. Playing this argument out in public, rather than trying to iron out differences behind closed doors, is causing shock waves in the markets. Every public spat is a step-back from reaching an agreement by August 2nd deadline. We wonder how long before the credit rating agencies get involved?

Politics is complicating price action in the markets. The dollar sell-off does look extended, but then who would want to buy dollars in an environment where the US may enter a technical default within the next week? Pricing in political risk is a notoriously difficult thing to do, so we wouldn't be surprised to see a sharp reversal if the two factions on Capitol Hill can start doing their jobs and come up with a resolution.

As I mentioned yesterday, the US has a lot of debt to auction this week, totalling around $200bn, these are the last auctions due before the August 2 deadline and so are a key litmus test for demand for US debt. An auction of short-term Treasury debt yesterday went off without any problems, but government data showed that there were more domestic buyers than foreign buyers at debt auctions last week and we would expect the same to happen this week.

Interestingly, the US debt crisis hasn't weighed on the Treasury market. Yields on 10-year debt are only back at early July levels. As long as there is an appetite for Treasuries from domestic investment funds then this could fill the gap left by foreign buyers and stop any threat of a meltdown in the US debt market.

So, credit markets are still calling Washington's bluff and expect an 11th hour resolution to the impasse.

Chart 1: Only small signs of stress in the Treasury market:

Treasury bond yields have started to rise while the dollar has taken another lurch lower, breaking its positive correlation of recent months. A weak dollar and higher yields is a typical sign of credit market stress. (10-year Treasury yield (white line) and Dollar index (orange line))

Chart 2: Washington scuffle increases intervention risk

Did the Bank of Japan intervene today? There was some strange price action in USDJPY early this morning. This is an hourly chart, after declining below 78.00, USDJPY spiked to 78.75, before quickly getting sold-off again. BOJ intervention risk is now a major impediment to USDJPY and could increase volatility.


Chart 3: Aussie as safe haven?

AUDUSD is making its way back towards its record daily close at 1.0971, above here sees to 1.1000 and then 1.1050/60. But be aware of event risk this evening. Australian Q2 CPI is released at 0230 BST/2130 ET. This is pivotal for the future outlook for monetary policy. If inflation pressures remain strong then this will keep the pressure on the RBA to hike rates. The Trimmed Mean CPI measure preferred by the RBA is expected to show prices rising at a 2.5 per cent annual rate, up from 2.2 per cent.

Rate expectations have fallen recently - 2-year bond yields have fallen by nearly 70 basis points since May. If price pressures are still building the RBA may have to retain their hawkish stance, which the

market is not prepared for. If inflation is higher this could boost yields and thus the Aussie, if inflation pressures are low to moderate it could have the opposite effect. So expect volatility in the Aussie going forward.


The chart below shows 90-day Australian rate futures (white line) and AUDUSD (orange line). As rate expectations have come off, the Aussie has continued to rise, partly due to the weak dollar. If we see rate futures rise this could propel AUDUSD towards 1.1000 and beyond.


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