U.S. debt row keeps dollar near eight-month low, stocks subdued

Reuters
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A man walks through the lobby of the London Stock Exchange August 5, 2011. REUTERS/Suzanne Plunkett

By Marc Jones

LONDON (Reuters) - The government shutdown and impending debt deadline in the United States kept the dollar near an eight-month low despite signs of a fight back on Friday and drove world shares towards a second week of losses.

With no real progress evident in Washington, financial markets were reluctantly facing up to the possibility the deadlock could extend to October 17, when the government will effectively run out of cash.

At the same time, hopes the row could be resolved without a catastrophe were helped by media reports House Speaker John Boehner had told lawmakers he will ensure there is no default, even if it means relying on the votes of Democrats as he did in August 2011.

"You can see markets are getting a bit more anxious on this but at the same time you have this possible chink of light," said National Australia Bank FX strategist Gavin Friend.

"It would be a kind of makeshift package that buys a bit of time, a year, maybe less than that, but at the moment the market would probably settle for that."

Investors were also taking the view that with expectations of a quick deal currently so low, the only risks over the weekend were on the upside.

The dollar (.DXY) was up for the first time in six days before the start of trading on Wall Street where the S&P 500(.SPX) was expected to bounce around 0.3 percent after its worst day in over a month on Thursday. (.N)

The U.S. shutdown delayed the closely-watched nonfarm payrolls data, normally out on Friday and a key factor in Federal Reserve deliberations on when to scale back its stimulus. The postponement had no noticeable market impact.

Several Fed officials are due to speak later in the day. Two senior policymakers, as well as the U.S. Treasury and the International Monetary Fund, warned on Thursday of dire consequences if the country defaulted on its debt.

ITALY SHINES

This week's troubles left world stocks on MSCI's global index heading for a second weekly loss in a row of 0.6 percent, but analysts saw that as of minor significance considering their recent strong run.

Asian shares had been led lower overnight by a weak Nikkei (NIK:^9452)in Tokyo but European shares (.FTEU3) overcame a difficult morning to stand almost flat on the day by 1200 GMT.

Italian stocks (.FTMIB), up 1.4 percent, enjoyed another strong day following this week's confidence vote for the country's fragile government which has cut the risk of snap elections that would have reignited euro zone crisis fears.

Italy's government bonds also outperformed leading a broad fall in euro zone periphery yields from Greece to Ireland.

"We are seeing reduced political risk in Italy following relief that Letta survived the no-confidence vote," said RIA Capital Markets strategist Nick Stamenkovic.

THE D-WORD

The focus remained mostly on the dollar (.DXY), however, after it hit an eight-month low against a basket of major currencies on Thursday following a 3.5 percent drop during the last three weeks of political wrangling.

Hitting the debt ceiling could lead to an unprecedented U.S. default, an outcome the market assumes is unthinkable.

"By far the biggest risk is October 17. If the debt ceiling is not raised beyond $16.7 trillion words like default are going to start rearing their head," said Neil Williams, chief economist at fund manager Hermes.

"Is the world's biggest economy really going to default on its debt when the wheels of the Fed's printing presses are still turning? I highly doubt it."

The euro had looked to be eyeing up its 2013 peak of $1.3711 in Asian trading, but as the dollar began to firm in Europe the single currency dropped back half a euro to $1.3585. Sterling also fall 0.75 percent to $1.6041.

Debt markets remained largely relaxed about the U.S. tensions, and yields, which move inversely to prices, were slightly higher on benchmark U.S. Treasuries and German Bunds as U.S. trading started.

Commodity markets remained choppy. Brent crude edged up 0.4 percent to $109.46 a barrel, reversing a 0.2 percent decline overnight after slower U.S. service sector growth in September compounded worries about demand for raw materials.

Gold was broadly steady at $1,312 an ounce while copper prices stabilized at $7,190 a tonne after tumbling 1.3 percent on Thursday.

(Additional reporting by Emelia Sithole-Matarise; Editing by John Stonestreet/Ruth Pitchford)

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