Overnight, the USD index made some upwards movement, although this was mainly premised on weakness in the euro.

USD/JPY managed to find some buying support after falling to 77.58 in early London trade, pushing up to an overnight high of 78.17. In the US session and into Asian trade, the pair pulled back below 78.00 as traders sold into the rally. Traders are trying to digest how asset classes will react if we see a ratings downgrade from one of the agencies, with JP Morgan suggesting ‘political wrangling over a plan to reduce the deficit may cost its AAA rating, adding $100 billion a year to government costs while dragging down economic growth.’ Investment bank Nomura also added that a US downgrade may cause the repo market liquidity to freeze. Overnight, the debt ceiling debate rolled on with no real breakthrough being made, and with the final outcome difficult to predict.

The impact on the USD in the medium-term could be significant; it has enjoyed reserve currency status over the past 50 years and this has been premised on the assumption that the US will honour its debt obligation. The ironic thing is though if we see a full default (while equity markets drop significantly), the USD may actually rally like we saw during the GFC. The price action on USD/JPY is still pretty bearish, and the USD will remain offered until clarity prevails.