A Possible Government Shutdown Threat Supports the Greenback

The U.S. Dollar is strengthening with the U.S. Dollar index (DXY) up by more than 0.5% to 105.72 this week. The DXY was even higher at 105.89 at some point, the highest since November 2022. 

The rise of the Dollar resumed after policy meetings of major central banks last week. The Federal Reserve (Fed) has demonstrated the most hawkish intentions despite takin a pause in interest rates hike cycle. Fed members suggested another interest rates hike this year, which came as a much-unexpected surprise for investors. Bank of England and National Bank of Switzerland, in contrary, took an unexpected break in interest rate hikes. The Bank of Japan disavowed the words of its Governor Kazuo Ueda on possible exit from its ultra-loose monetary policy that is lasting for decades.

All these developments supported the Dollar and granted it 0.1% weekly gains despite it has posted losses of 0.7% earlier last week. The Greenback continues to strengthen this week as a possible U.S. government shutdown is nearing. The new fiscal year in the United States starts on October 1, though the Congress does not approve the federal budget yet. The talks over budget spending are stalling, while there are no even temporary solution in sight. This week is the last one to resolve budgetary crisis. Every week of a shutdown is an equivalent of 0.2% GDP. A shutdown is not something unusual for American policymakers, as America passed through this process several times and recovered all these losses afterwards. However, this time it is very complicated as politicians are seen very far from striking a deal. Investors fear that they have largely overestimated U.S. stocks.

Meanwhile, Moody’s rating agency has warned that this shutdown would threaten country’s triple-A rating. Moody’s is the last from a big three rating agencies that keeps the highest rating for the U.S. intact.

So, this is a very dangerous situation as major declines of stock markets like in 1929 and 1987 happened in October Large U.S. hedge funds are increasing short positions posting a largest increase since a collapse in 2020. Shutdown in the United States would certainly derail markets. All this is amplified by additional hawkish pressure by the Fed, inflation aftershock threat amid rising crude prices. In a normal situation, such shocks could result in strengthening of the Greenback. And this is what we can partially see in the market. But what if the United States will become the core of these troubles? Would investors continue to invest in the U.S. debt considering it as a safe haven? 

There is no answer neither in the history nor in current market indications. There was no such situation in the last four decades when the highest credit rating of the United States was really questionable. Political crunch now is far worse as Republicans are in chaos with its hardliners blocking any compromise.

Technically, the situation is also uncertain as the U.S. Dollar is seen strongly overbought with a correction just around the corner. This is strongly supported by the weakening inflows to the WisdomTree Bloomberg U.S. Dollar Bullish Fund that is aimed to a rising Greenback. On the other hand, the Dollar is dominating over the Euro and the British Pound as the U.S. economy is strong. This might be enough for the Greenback to continue up to make a parity with the Euro in the mid-term.