Top of the Morning: POTUS 47 - Government gridlock, Trade update
The desk posits that extended government shutdowns are contributing to heightened market uncertainty, creating pressure in the FX landscape. As per the full note from UBS, the shutdown, now in its third week, marks a critical juncture, historically aligning with significant fiscal disruptions. Additionally, the resurfacing U.S.-China trade tensions inject further volatility into the market dynamics, which should be monitored closely as they influence investor sentiment and currency positions.
What the desk is arguing
The current government shutdown, now on day 20, is poised to become the longest since 2013, which may drive further instability in the financial markets. According to UBS, the stagnation stems from unresolved negotiations on key issues such as the expiration of enhanced subsidies under the Affordable Care Act, which are pivotal to Democratic support. This stalemate suggests a prolonged period of uncertainty for investors seeking direction in the FX markets.
Moreover, while the anticipated impacts on economic activity are beginning to materialize, the lack of substantive resolution signals a potentially difficult negotiation ahead. Observers should note that past instances of prolonged shutdowns have historically led to adverse effects on market dynamics, with spillovers to currencies depending on fiscal and trade-related signals.
Where it sits in our coverage
Our consensus target for the EUR/USD pair currently sits at 1.075, with a range spanning from 1.04 to 1.12. Notable targets from respected firms include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns closely with jpmorgan’s positioning at the upper range, indicating a skew towards a more favorable outlook in response to weakening dollar sentiment despite ongoing gridlock.
How other firms see it
Firms aligned with the bullish sentiment on the euro include jpmorgan, which reinforces the outlook with a target above our consensus. Conversely, bofa holds a more contrarian stance, with their forecast indicating a considerable downside risk for the EUR/USD.
Significant interaction with related currency pairs, such as USD/CNY, is expected as the ongoing trade tensions resurface, emphasizing the need for traders to keep focused on geopolitical developments and central bank communications that could shift sentiments in the FX markets.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The U.S. government shutdown has entered its third week, creating uncertainty in the financial markets.
- 02Ongoing negotiations, centered around the Affordable Care Act, show little sign of resolution, increasing market volatility.
- 03U.S.-China trade tensions are resurfacing, further complicating the economic landscape.
- 04Investors should watch for the historical impact of prolonged government shutdowns on currency movements.
Market implications
Looking ahead, the EUR/USD is projected to experience fluctuations given the backdrop of the ongoing U.S. government shutdown. Traders should watch levels approaching 1.075 for indications of further movement depending on resolution timelines from Washington.
Risks to this view
A swift resolution to the government shutdown could nullify current bearish sentiment leveraged against the dollar, prompting a rapid adjustment in FX positions. Additionally, easing U.S.-China trade tensions may lead to stronger dollar rallies, reversing current trends.
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
For today, we are going to continue with our series of monthly POTUS 47 conversations. Joining us here for the conversation today on this Friday, glad to welcome back Kurt Reiman, Head of Fixed Income for the Americas with the UBS Chief Investment Office. Kurt, thank you for dropping by.
I know we have a lot to catch our listeners up on, so looking forward to our conversation. Welcome back. Me too.
Thanks for having me back on the show, Dan. Definitely. And before we begin, quickly, I want to remind our listeners, our clients, that they can stay informed on POTUS 47 coverage by visiting the UBS website, ubs.com forward slash POTUS 47, where you will find regular updates and resources as it relates to POTUS 47.
So, Kurt, we do have a lot to cover, so let's dive right in. I know as we're speaking today here on Friday, October 17th, the U.S. government shutdown is at this point well into week three. What dialogue negotiation is taking place amongst lawmakers in order to restore the impact in government functions, services, and what factors have been holding up progress?
Yeah, so quickly, just on a report card for where things stand, you know, the shutdown started on the 1st of October, so it's easy to track how many days we're in. Today represents the 17th day, and that's notable, because the last time we had a full government shutdown was in 2013, and guess what? It ended on the 17th.
So, we are going to be, by this weekend, at the longest full government shutdown since 2013. You know, by Monday, we're going to be on day 20. On Wednesday, it'll be the start of the fourth week, and I, you know, to your question, there's very little substantive that would suggest that lawmakers are close to ending the shutdown.
At issue is this enhanced premium subsidies that, for the Affordable Care Act, these expire at the end of the year, and Democrats are using the shutdown to press for those subsidies to be extended, and Republicans so far are unwilling and potentially even unable to secure the necessary votes to extend them, especially during the shutdown. What's interesting is that the subsidies that expire would lead to rising health care premiums somewhere on the order of 12 million. It would affect 12 million Republicans and about 9 million Democrats.
So, in theory, this issue would garner bipartisan support, but yeah, we're not living in an era of bipartisanship on these issues, and it's especially on issues related to federal spending. So, we've seen some, you know, kind of early trial balloons that have been floated. You might have heard recently, Majority Leader Thune suggested that they would put a vote to the floor of the Senate, but that's not a guarantee, and the vote would, of course, be on the expired subsidies and extending them.
So, you know, and then on the economic side, you know, like sort of what are the forcing mechanisms? What would bring, you know, the parties together? And it would be things like, you know, a weaker economy or maybe the poll numbers start blaming, you know, the Americans start blaming one party or the other, and there hasn't been really much of a, you know, obvious impact on the economy from the shutdown.
The administration has already taken some moves to pay active duty troops and law enforcement officers, and if you look at the poll numbers, Americans are saying basically that both parties are equally to blame. That'll shift, and that's probably what's going to end up being the forcing mechanism for the shutdown to end, but right now, there's little evidence that shutdown's going to end anytime soon. It could very likely drag into November.
So, Kurt, with that, in terms of impact at this point to financial markets, economic activity, is there anything notable to point to? Not really. You know, the equity market has not been taking its cues from the government shutdown.
We're in the midst of Q3 earnings season. Last weekend, there was, you know, a little bit of a minor tremor around tariffs, which at least seems to be fading. Some concerns, as I'm sure you and previous guests talked about, on some of the fraud that's been creeping into credit markets.
So, yeah, that's largely been the driver of financial markets, and, yeah, it's too early for the shutdown to be impacting the economy, and in any case, we don't have too many examples of government shutdowns that have lasted longer than a week. There's really three, and the last one was in 2018 that lasted for 34 days. It was partial, and just as a reminder, because we talked about this last time, the Congressional Budget Office did a study, and their take was that it cut about two hundredths of a percentage point off of potential GDP in 2019.
So, like, basically a rounding error, and that's because any funds that aren't dispersed in the form of salaries will get paid. They'll get made up once the government reopens. So, there's some part of the economy that gets permanently lost from a shutdown, but it's not a lot.
We'd have to see this last much longer. Other drivers are far more powerful. That's something that we said ahead of the shutdown, which is, if you think about the 2018-2019 shutdown, the impact was far more around the Fed raising rates, and what at that point was some of the delayed effect of some tariff action that had taken place earlier in the year.
And likewise, this time around, the Fed is in rate cutting mode. Earnings have come out pretty well for the financials that have reported so far, and the economic data has mostly held up, and the tariff news wasn't enough yet to cause any sort of lasting damage. Well, Kurt, that was a very helpful update in terms of how we got to where we are today, where negotiations currently stand, and hearing about the scope of impact to financial markets and economic activity.
Another topic to spend some time on today, separately, we have seen financial markets rattled recently by renewed trade tensions involving the U.S. and China. Kurt, do you have a sense for where relations stand as of today? What exactly triggered this recent volatility?
And is a previously suggested upcoming meeting involving President Trump and President Xi Jinping still on track? Seems to be on track. I'd say that coming into the weekend last Friday, it was a series of microaggressions that, kind of minor irritants that were, well, they weren't really minor depending on the perspective, whether it was some port fees on ships or changes in export restrictions or adding companies to these entity lists.
These are, you know, we kind of had a period of coming together around these summits in various cities and the mood music was, you know, kind of moving in the right direction. But these minor microaggressions that were coming on were just kind of building on one another. And it's hard to say, you know, was one side playing offense or another side playing defense?
You know, it's hard to say which side, if we wanted to, started it. It was, it was kind of just a series of escalations. And then it, you know, it ended up with the threatened 100% additional tariffs on China and the rare earth restrictions coming back onto the radar screen.
And then of course it faded, but this is, I would read this as both sides trying to get maximum leverage going into whatever next meeting they will have, which is around the APEC summit and being able to use that as the starting point for a series of follow-on discussions. And so, yeah, we've, we escalated, we deescalated, we could be in for, you know, kind of repeated periods of escalation, but our base case is that neither side wants this to turn into a lasting heightened war that would lead to economic damage. China can't afford it.
It's, you know, working to prevent deflation and the leverage that built up over many years from undermining the economy. And, you know, the administration is really working hard here to support economic activity. So the idea of getting back to something that we saw in April, seems like that landing, you know, we're going to land on a zone that's around where we are now.
Of, in our view, somewhere between 30 to 40% tariffs on China. We're at 40% now. So it's, you know, what matters, Dan, is the summit.
What matters also is the, you know, the relationship between the two leaders, but also something that's not getting a whole lot of airtime. And, you know, I won't go into too much detail, but the Supreme Court is going to be taking up the oral arguments on November 5th. In the case that's been working its way through the lower courts, the Court of International Trade, the U.S.
Federal Circuit Court of Appeals, both had ruled that the tariffs on China, the fentanyl tariffs, baseline tariffs, the tariffs on Canada and Mexico, the ones on Brazil, these are under the International Emergency Economic Powers Act, better known as IEPA, that's going in front of the Supreme Court on the 5th of November. They're going to hear the oral arguments, they're going to hear from both sides, and they're going to have a decision before the end of the year, or early next year, whether they're legal or not. And if they're legal, well, you know, then we have kind of a status quo.
If they're illegal, the whole landscape changes on tariffs. So I guess when we think about the tariff impact on financial markets, just sort of, you know, bringing it home, you know, what does it mean for the markets, we have been through a period where the view around these higher tariffs has been largely, you know, the markets have taken it in stride. It's been an order adjustment tax.
We haven't really gotten into an all-out trade war. There have been deals. So it's allowed the market to trend higher.
From here, yeah, the landscape's going to change. We're not at a point where we can say that it's going to change in a way that is potentially damaging for markets and the economy. But we do have to be on the lookout.
We have to be following this. We have to be really, you know, sort of not taking this view that just because tariffs haven't been bad, or they've been benign, that they will continue to be. So, you know, I think it's something that we have, and we will be keeping a close eye on.
But as far as the China-U.S. relationship goes, you know, 30% or so of the tariffs that have been imposed, maybe that's too high, closer to 25, have been in this category of IEPA. And if they're declared illegal and they go away, companies are going to get a huge windfall because they'll be entitled to a refund if they paid those tariffs. And, you know, and we may end up in a much lower, you know, tariff zone between the U.S. and China.
So, or maybe slightly lower tariff zone than we see today. So there are potentially positive outcomes. You know, we may end up in a world where both countries end up, you know, using export restrictions more.
But it's just to say that the landscape could be quite different in a couple of months from now, depending on the Supreme Court ruling. So we'll stay tuned. Yes, indeed.
And Kurt, I know our next conversation is coming up in just a few weeks' time. So hopefully at that point, the government shutdown will be in the rear view, as it sounds like there is a lot to discuss and be mindful of when it comes to U.S. trade policy and these ongoing negotiations with China. So, Kurt, thank you again for dropping by the podcast, keeping our listeners, our clients informed, and do look forward to our next upcoming conversation.
Same here. Have a great weekend. Thank you, Kurt.
You as well. Again, today we have been joined by Kurt Reiman, head of Fixed Income Americas with the UBS Chief Investment Office. Again, I do want to point you, our listeners, to the POTUS 47 website, which updates on a regular basis with resources as it relates to POTUS 47.
From the UBS Chief Investment Office, that's UBS.com forward slash POTUS 47. From UBS Studios, I'm Dan Cassidy. Thank you for joining us.
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