Optimism increasing as Fiscal Cliff negotiations show promise

Thirteen more days until the Fiscal Cliff deadline. Three more days until the end of the world, at least according to an abstract interpretation of the Mayan calendar. I hope you all have a hand basket handy. On that sunny note, happy Tuesday everyone. Regarding the Fiscal Cliff, it seems politicians in Washington are beginning to coalesce around some compromises, but it looks like it will be coming right down to the wire as to whether they reach a deal before December 31st, the date the automatic cuts and sequestration go into effect. As I’ve mentioned previously, the main sticking point has been raising taxes on the wealthy. Obama’s initial offer was that taxes go up starting on individuals earning over $200k. House Speaker John Boehner and Republicans had dug their heels in about any increase on taxes, but Boehner in recent meetings had suggested that number be set at $1MM, although it is uncertain whether he has the votes in his caucus to even get that, despite an overwhelming majority of Americans who believe those rates should go up for the wealthy. Today, they emerged from a meeting and it seems the new number being tossed around is $400k. There are a host of other spending cuts and debt limit implications that are included in the compromises, with the main difference in opinion being on spending cuts centered around the entitlement programs of Social Security and Medicare. Regarding Medicare, Republicans want to increase the age from 65 to 67. A notion Democrats have flatly rejected. While the two sides continue to wait for the other to flinch, it does appear that they seem to be offering up some concessions on both sides of the aisle. This is refreshing from the gridlock that seems to have gripped Washington over the past couple of years. At this point, it is too early to predict whether they will get a deal done before the deadline, but it appears they will be working over the Christmas holiday if they are to get a law written and approved.

The improving tone of the fiscal cliff negotiations has caused investors to become optimistic recently. U.S. stocks climbed on Tuesday, putting the S&P 500 on track for its best two-day run in a month. The gains followed a rally on Monday that lifted the S&P 500 to its highest point in nearly two months.

In FX markets, the improvement in equity markets, both in the US and in Europe, caused risk appetite to soar. The Euro hit a 7-month high today, topping out around 1.3224. The rally in the EUR/USD gained additional momentum after Standard & Poor’s upgraded Greece’s sovereign debt rating by a whopping 6 notches to B- with a stable outlook from Selective Default. In addition, the noose around Spain and Italy’s necks have loosed with 10 year bond yields moving lower once again. Unless US politicians turn back the clocks back on the progressing fiscal debts talks (and we shouldn’t rule that out based on their past performance), look for the Euro to go even higher.

The Pound has also benefited from the improvement in risk appetitive as the greenback has lost its safe haven allure. It gained around 2 and ½ pence over the past week and half moving up from 1.6000 to around 1.6250 today. The Euro added about 2 ½ cents in that timeframe as well.

Japan has been another big mover in FX markets recently. The yen has continued to slide against most of the major currencies following Sunday's election of the Liberal Democratic Party. Expectations that the new government will drive the Bank of Japan toward more aggressive policy easing have been fueled heading into the BOJ's two day policy meeting. In addition, the Yen is also seen as the “other” safe haven” currency so the continued rise in risk appetite has caused its value to sink. The USD/JPY pair went up over 2 cents from around 82.00 to 84.26 today. This is a welcome reprieve for Japanese exporters who have struggled to compete in the global market while its currency has gained strength over the past years.

Going forward into the end of the year, the FX markets will likely be focused on the Fiscal Cliff dilemma. If the conditions improve in negotiations, the greenback will likely see its value fall across the board as appetite for higher yielding, riskier assets improve.

For additional information please call (408) 556-8377.

Regards,

Brian Simonson
Senior Vice President - FX Trading

Bridge Bank, N.A.
55 Almaden Boulevard
San Jose, CA 95113
T. 408.556.8377
F. 408.275.0362
Email

Disclosure

Bridge Bank cannot accept liability for any inaccuracies that occur. No statement is to be considered as a recommendation or solicitation to buy or sell securities or other instruments or to provide investment, tax, or legal advice. Readers should be aware that the information provided is not intended to replace professional advice in relation to any topic discussed.

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