How the Debt Ceiling Debate Hits Currencies

Alfred E. Neuman

Have you noticed a certain Alfred E. Newman tone to the currency market lately?

Currencies are moving, but the shifts have nothing to do with the prospect of a battle royal over the debt ceiling. It's as if forex traders are saying, "what, me worry?"

The reason is that investors are all too familiar with political brinksmanship, says Steven Englander, global head of G10 FX strategy at Citigroup. "The past three fiscal driven sell-offs have had increasingly little market impact," he wrote in a note to clients. "We suspect investors in FX and other markets have become conditioned to last minute resolutions to U.S. fiscal crises and are increasingly jaded with respect to the political process that will generate the solutions."

Congress and President Obama patched together solutions, however temporary, to both the2011 debt-ceiling fightand the fiscal cliff showdown. As a result, Englander says, investors seem to be expecting a resolution to the current set-to over the debt ceiling as well.

(Read more: National Debt: CNBC Explains)

All this is good news for risk-sensitive and emerging market currencies, in Englander's view: "the risk on trade for EM and G10 risk-correlated currencies may have a month or six weeks to go before there is any indication that FX investors are even aware of what is going on in Washington."

But if the debt ceiling is ultimately breached, watch out. Those risk-sensitive positions coudl be unwound in a hurry. "It may look as if the debt ceiling breach is not worrying asset markets, but it means that investors are banking on the chestnuts being pulled out of the fire," Englander says. "If they are not pulled out, positions go up in smoke."

Fasten your seatbelts. It should be quite a ride.

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