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US Dollar in Focus as Debt Ceiling Deadline Looms

A government shutdown in the US looms if lawmakers cannot find agreement - here's a look at what it might mean for the Dollar.

The Dollar faces a testing period ahead as lawmakers in Washington turn their attention to the annual debt ceiling debacle which, if unresolved, could see the US government forced to shut down as early as next week.

A government shutdown is the process the Executive Branch must enter into when Congress and the President fail to pass emergency legislation to fund government operations and agencies.

A temporary extension to the debt limit, agreed in September, is set to expire Friday, 8 December. Extraordinary measures, such as a government shutdown, could enable the Treasury to meet its obligations for several months.

Congressional Budget Office staff estimated in November that these measures could see the Treasury through until early April, meaning fears of a technical default by the United States should remain benign until then.

A government shutdown is politically contentious as it almost always means the furlough of federal workers. In the December month, right ahead of Christmas, this can be costly for lawmakers who will face mid-term elections in 2018.

"The foreign exchange market has remained relatively stable during the Asian trading session with the US Dollar on a stronger footing against the other major currencies in anticipation of the increased likelihood that the US government will pass tax reform legislation before year end. There have also been encouraging reports that Congress appears on track to approve legislation to avert a partial government shutdown over the weekend," says Lee Hardman, a currency analyst at MUFG.

Government shutdowns are, however, essential when the Treasury is locked out of debt markets because it must prioritise the conservation of cash in order to meet scheduled repayments on existing debts of the United States.

Senate and House republicans are expected to vote to approve another temporary extension of the debt limit some time on Friday. This is seen enabling the Treasury and federal government to go on borrowing, to fund existing obligations, until December 22 or after.

The last time a government shutdown took place was late in 2013 when Republicans forced workers into furlough after ideological differences around the Obama administration’s fiscal approach meant an extension of the debt limit could not be agreed before the appropriate deadline. 

Implications of a government shutdown for the Dollar are less clear than they are for federal workers and lawmakers. Much has been made in recent days of the growing yield-gap between short term US government bonds and their overseas counterparts, which has lent support for the Dollar.

While expectations around tax reforms are commonly seen as the main driver behind higher US yields, there are signs the debt ceiling debate is also exerting some influence.

Treasury bills maturing on April 12 currently offer a higher yield than those that are set to mature one week later, after the point at which Treasury is estimated to have run out of cash, according to a Bloomberg report.

This suggests a bet by the market that the US will ultimately avoid default. But it also suggests investors are demanding an increased risk premium for holding US bonds that mature over the coming months.

The US Treasury will auction a three month bills on December 26. Maturity of these bills will coincide with the estimated April deadline for when government coffers will run empty and so the yield demanded at auction could be a useful barometer of how concerned investors over the debt ceiling at that time.

The US Dollar was bid broadly higher during morning trading in London Thursday, pushing the Dollar index up by 0.19%.

The greenback gained 0.22% or more against the Yen, Swiss Franc, Euro and the Australian, Canadian and New Zealand Dollars. Sterling was quoted 0.01% higher against the Dollar at 1.3391.

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