This is a meme we’re picking up more and more: That the market is just getting inured to Washington crises, and doesn’t really care.
Maybe the market cares for a bit at the last second, but the whole dance has become so cliches, that it’s just not worth panicking until you absolutely have to.
In a note out this morning, Citi’s currency export Steven Englander predicts continued calmness by markets up until the very end. Then horror if it really looks like something isn’t going to happen. The title of his note is “First complacency, then horror.”
Asset market markets are likely to ignore the debt ceiling till the last minute, or even later, and then react on panic if it gets breached. For FX this means that 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.
The reason is that the past three fiscal driven sell-offs have had increasingly little market impact. The July 2011 debt ceiling crises + downgrade led to more than 15% drop in US equities. Right after the November 2012 election we had a bout of fiscal cliff worries that gave us a 5% correction, but when talks broke down in late December, equities barely budged. We suspect investors in FX and other markets have become conditioned to last minute resolutions to US fiscal crises and are increasingly jaded with respect to the political process that will generate the solutions. Hence the tendency will be to hold on to risk even longer on the view that ‘don’t worry, something will turn up’, just as it has in the past.
Dan Greenhaus of BTIG noted the same kind of complacency in his note last night:
In more and more client meetings, including two today, the topic of hedging strategies arose around the debt ceiling discussion. To repeat our view, we simply have no idea how the debt ceiling discussions will shake out, nor the discussions surrounding budget negotiations. One thing we can say though is that January VIX futures will tomorrow probably settle at the lowest level since 2007. As the chart below illustrates, volatility has been reduced with each successive macro scare and some clients still tell us not to worry.
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