U.S. Government Shutdown and Market Response

The U.S. federal government entered a shutdown at the start of the new fiscal year on October 1, due to Congress’s failure to pass any appropriations legislation. While this has caused significant disruptions for federal employees, their families, and certain projects—particularly in opposition-led states targeted by the administration—the capital markets have largely remained unfazed. Notably, the absence of high-frequency economic data, including the September employment report, did not prevent major indices from reaching record highs last week. Both the S&P 500 and Nasdaq closed at new highs, as did Europe’s Stoxx 600, the MSCI Asia Pacific Index, and the MSCI Emerging Market Equity Index.

Treasury Yields and U.S. Dollar Performance

The 10-year U.S. Treasury yield declined by nearly three basis points last week, marking the largest drop among G10 sovereign bonds. The two-year yield fell slightly more than five basis points, a movement that includes a modest rebound just before the weekend. The U.S. dollar weakened across most major currencies, although it lagged against the Canadian dollar, which showed relative resilience amid the soft greenback environment.

The government shutdown is expected to continue into the following week without a clear resolution in sight, as both political parties appear to see potential electoral advantages heading into November’s midterms.

International Developments

Japan

Japan’s ruling Liberal Democratic Party selected Sanae Takaichi as its new leader, positioning her to become the country’s first female prime minister pending a parliamentary vote later this month. Her leadership is anticipated to influence fiscal and monetary policy dynamics, given her advocacy for supplementary budgets and maintaining the Bank of Japan’s accommodative stance.

Czech Republic

Elections are scheduled in the Czech Republic, where populist leader Andrej Babis is favored to win. This outcome could lead to a reduction in direct military support for Ukraine by Prague.

Data and Central Bank Activity Ahead

With limited data releases from the U.S. due to the shutdown and reduced activity during China’s extended holidays, market-moving news from the world’s two largest economies remains minimal. The Reserve Bank of New Zealand is the sole G10 central bank scheduled to meet next week. Market participants show more confidence in a 50 basis point rate cut by the RBNZ than reflected by swap pricing.

Key economic indicators expected in the upcoming week include:

– Labor earnings and household spending data in Japan
– Factory orders and industrial production in Germany
– Canada’s trade balance and employment figures
– September inflation and industrial output data from Mexico

U.S. Market Drivers and Data Calendar

Historically, U.S. government shutdowns have exerted limited influence on capital markets and the broader economy, with GDP estimated to contract by approximately 0.1% for every week of closure. Given the wealth of Federal Reserve and private sector data available, as well as monetary policy decisions primarily driven by forward-looking conditions, the expectation remains for the Federal Open Market Committee (FOMC) to maintain its scheduled rate decision at month-end.

Despite the shutdown, the Treasury will continue its debt issuance, rolling out roughly $119 billion in coupon-bearing securities and more than $250 billion in bills.

Upcoming Releases

– August consumer credit data
– FOMC minutes, potentially highlighting new Federal Reserve Chair Jerome Powell’s insights, including commentary on a reduced real neutral rate of interest (r\*) influenced by prior fiscal policies
– Preliminary University of Michigan October consumer sentiment survey

Currency and Bond Market Summary

U.S. Dollar Index

The Dollar Index ended a two-week rally last week, declining by approximately 0.4%, and settled into a broadly consolidative pattern. Technical analysis suggests that a decisive break outside the 97.40–98.15 range could be significant, but the market awaits fresh catalysts. Overall sentiment remains tilted toward dollar weakness.

Eurozone (EMU)

The euro’s downward momentum following the mid-September FOMC meeting has slowed, closely tracking the interest rate differential between U.S. and German two-year bonds. Germany continues to face economic headwinds, with industrial stagnation in the first half of the year and only modest expected GDP growth in the third quarter.

Upcoming European data releases:

– Germany’s factory orders, industrial production, and trade figures
– France’s trade balance
– Italy and Spain’s industrial output reports

Political risks remain elevated as French socialists challenge the government’s budget plans, with a potential confidence vote looming. Moody’s will also review Belgium’s credit rating, which currently has a negative outlook.

Euro Performance

The euro appreciated about 0.25% last week, marking its seventh weekly gain in ten. Key technical resistance levels are at $1.1780 and $1.1815, while support remains near $1.1645. Momentum indicators suggest a continued period of consolidation.

China

Chinese authorities continue to manage the yuan’s exchange rate closely relative to the U.S. dollar. Mainland markets remain closed for the national holiday until October 9, with limited data expected during this period. Market participants will monitor September’s foreign reserves and lending figures upon reopening.

The yuan has hovered near CNH7.13 against the dollar and is expected to trend lower once trading resumes.

Japan

The yen remains sensitive to U.S. interest rate movements. The election of Takaichi as LDP leader and likely prime minister may impact the Japanese Government Bond market due to her stimulus-oriented fiscal policies and support for the Bank of Japan’s dovish monetary stance.

Key data releases include labor earnings, household spending, and the August current account balance. The market currently prices roughly a 75% chance of a BoJ rate hike before year-end.

The dollar recently retraced from near JPY150, dropping to approximately JPY146.60. Technical analysis implies a potential test of September’s two-month low near JPY145.50, though upward momentum could resume under the new leadership, with resistance around JPY147.85 and a possible target zone at JPY148.25–65.

United Kingdom

Sterling remains closely correlated inversely with the U.S. dollar. Changes in long-term UK government bond yields occasionally influence exchange rate extremes. Upcoming UK data is limited to the construction Purchasing Managers’ Index and house price reports, which typically exert minimal market impact.

Sterling’s recent recovery stalled near the 50% retracement level of its earlier decline at approximately $1.3525. Breaks above this could target $1.3570, while support is found near $1.3400 and more decisively at $1.3370, suggesting a retest of the recent low around $1.3325.

Canada

The Canadian dollar’s movements remain strongly linked to the broad U.S. dollar trend, with a correlation near 0.65 over the past month. An inverse relationship with the S&P 500 reflects risk sentiment’s role in exchange rate fluctuations. Trade tensions with the U.S. and China have weighed on the Canadian economy, with markets pricing a near 95% probability of further Bank of Canada rate cuts in Q4.

Market focus will be on the August merchandise trade balance and the September employment report. The goods trade deficit stood at approximately CAD 24.5 billion in the first seven months of the year. Job creation has slowed considerably, with only 37,500 net positions added in the first eight months versus 210,000 in the prior year. The unemployment rate remained elevated at 7.1% in August, the highest since the pandemic period.

Technically, the USD/CAD pair approached CAD 1.3985, just below the 200-day moving average near CAD 1.3990. Momentum indicators are stretched, suggesting a possible short-term reversal or consolidation.

Australia and New Zealand

The Australian dollar’s inverse correlation with the Dollar Index remains robust at around -0.80. Its relationship with the short-term interest rate differential between the U.S. and Australia remains moderate.

Australia’s economic calendar is sparse, but attention will focus on the Reserve Bank of New Zealand’s meeting on October 8, where another rate cut is widely anticipated. The RBNZ has reduced rates in the previous eight consecutive meetings, lowering the overnight cash rate from 5.50% last August to 3.0% currently. Market pricing indicates at least one more cut before year-end, with the cycle extending into 2024.

Sweden’s Riksbank Deputy Governor Per Jansson will assume the position of RBNZ governor starting December 1.

The Australian dollar rose close to 1% last week after earlier declines, trading in a narrow range around $0.6570 to $0.6630. Momentum indicators suggest sideways movement may continue, with a potential upside bias. A break above $0.6630 could target the $0.6700 level.

Mexico

The USD/MXN pair maintains a strong positive correlation with the Dollar Index, near 0.75 over the past 30 and 60 days, reaching decade-high levels. Correlations with U.S. two- and ten-year yields have eased slightly since late September but remain elevated.

The Bank of Mexico will meet in early November, with the September Consumer Price Index (CPI) report due on October 9 serving as a key input for policy decisions. While headline inflation remains within the central bank’s 3% ± 1% target band, core inflation exceeds 4%. The bank’s primary concern is on supporting growth, expecting inflation pressures to subside.

Industrial production fell approximately 0.7% through July this year, and Q3 economic growth may be flat after a 0.6% expansion in Q2.

The overnight policy rate stands at 7.50%, but swap markets are pricing in potential easing toward a terminal rate near 6.75%.

Technically, the USD/MXN traded lower early last month, reaching a yearly low near 18.20 pesos, but has since fluctuated between 18.24 and 18.56. Near-term momentum lacks conviction, though the interest rate differential favors peso accumulation. A close above key resistance at 18.50–51 pesos could propel the pair toward the 18.60–65 area.

Disclaimer

This summary is intended purely for informational purposes and should not be interpreted as investment advice or a solicitation to trade financial instruments.