Yesterday’s threats by President Trump to shut down the government caused only mild market reaction. However, there’s a real chance this situation could develop into a ‘live' issue for markets over coming weeks. If it does, gold prices should benefit and it may pay for traders to be aware of the issues.

Background

President Trump wants $1.6bn government funding for the border wall between the US and Mexico. The House failed to oblige in its May spending bill.  A new spending bill is due by 30 September and President Trump is threatening to veto all legislation unless it includes funding for the wall.

The US Government also needs to increase its debt ceiling. Failure to do so could create a major problem for the US and be a big risk event for financial markets. It could result in the US government missing debt payments. That’s a precedent that could call into question the assumed “risk free” status of US government debt and lead to significant financial market moves.

There are deep divisions both within the Republican Party itself and between Republicans and Democrats on the appropriate mix of spending and tax measures to get US government finances onto a sounder long term footing. Agreeing on a spending bill is not going to be easy

One possible tactic to force compromise would be to tie the spending bill to the debt ceiling bill. The theory is this would raise the stakes of not approving some sort of spending measure, providing more incentive for compromise

Markets are fairly used to threats of a government close down and to politicians running this situation to the brink. The real concern would come if this remained linked to the debt ceiling and a situation arose where by playing hard ball on spending measures and the wall, the President forced a situation where the US defaulted on debt obligations

Opinion

Readers will have their own views on all this but here is my thinking on possible key drivers for markets in coming weeks

  • It seems to me, there is a good chance that President Trump could play hard ball on this issue. The wall is a signature policy with his political base and he needs a win. He could be seen as strong by taking a tough stand on this
  • Markets have been consistently reluctant to engage in major “risk off” moves this year. They have become a little jittery from time to time but the gap between the earnings yield on stocks and bonds is large. The cost of getting out of stocks is high. Markets have waited for clear evidence of major problems before selling out of equities. There has been a tendency to buy gold and the Yen rather than seriously sell stocks
  • If the President does play hard ball on this the key will be whether the House continues to link the spending and debt ceiling bills. The House could kick this can down the road by temporarily increasing the debt ceiling independently of the spending issue. If that happens the threat of government closure while not good, would have less profound implications for markets

Market impact

If this year’s history is a guide, markets will be content to have a watching brief on this issue unless it gets really serious. That could mean continued higher volatility and some buying of gold and the Yen as we get towards the end of September but no major risk off moves unless it starts to look like the US might really be forced to default on debt payments.

If the market gets a sense that there’s a real chance of the US defaulting on debt there could be some big moves

The thing for traders to focus on will be the US debt ceiling.

Gold

Gold is likely to be a winner if concerns over US debt mount. Not only will there be a traditional flight to safety but the US Dollar could come under pressure adding upward momentum to the gold price

To summarise my chart outlook for gold:

  • $1375 looks like a key level for gold. It’s the July 2016 peak and the 38.2% Fibonacci retracement of the whole $1921/1046 decline. A break above this level could be bullish for a larger upward retracement (see monthly chart above)
  • In the meantime there is significant resistance on the weekly chart between $1296 and $1320. A break above this is likely to indicate the market is getting seriously concerned about the wall issue (see weekly chart below)

Gold Strategies

For those who see the wall issue as a significant risk over coming weeks, gold strategies could include:

  • Unless the issue is resolved, buy gold on any dip that allows setting a close sell stop loss under a recent low or short term support level OR
  • Buy gold on a clear break above the $1320 resistance