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Why Washington Dysfunction May Dent the Dollar

Steven Marks | The Image Bank | Getty Images

Yes, it's okay to breathe a sigh of relief now that Congress has averted the worst consequences of the "fiscal cliff."

Just don't get too comfortable. There are plenty of storm clouds ahead.

The minimal agreement of Jan.1 means "a great round of applause for everybody, but the rest of it is a frigging disaster," said Tommy Molloy of FX Solutions.

"What's kind of gotten forgotten among all the shenanigans and back slapping is the debt ceiling coming up," he added. "I think from a general longer term sovereign rating point of view, that has much more importance than the 'fiscal cliff' that's been driving everybody demented for the last three months."

Molloy worries that a big battle on the debt ceiling could lead credit rating agencies to cut the U.S. debt rating, as Standard & Poor's did around the time of the 2011 debt-ceiling debacle.

(Read More: What Is the Debt Ceiling?)

"The first notch off can be ignored," he said, alluding to the move by Standard & Poor's. "The second can not. You're starting to look like Europe."


The implications for currencies are mixed, in Molloy's view. He thinks events in Japan could drive the yen lower against the dollar, and the euro and pound will also likely trade in reaction to domestic events.

Camilla Sutton, though, is more downbeat. Sutton, the chief currency strategist at Scotiabank, thinks a downgrade would hurt.

"Leading into a downgrade the USD might have a brief period of strength on risk aversion; however the longer term impact is likely to be USD negative," she said.

Not everyone is worried about the currency implications of Washington's woes, however. Marc Chandler, chief currency strategist at Brown Brothers Harriman, is doubtful that Congress can reach agreement on the larger fiscal issues it should be address. But he's not particularly worried about the impact of a potential credit rating cut, noting that major rating agencies have had U.S. debt on watch for some time.

Chandler is also relatively sanguine about the dollar, even in the face of Washington dysfunction."Other countries have their own problems and are not in a position to impose their will on us," he said. "They are still buying dollars."

You be the judge.

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