US deadlock fears weigh on shares, dollar off lows

Faint signs of movement on the fiscal standoff in Washington helped lift the dollar off an eight-month low on Tuesday, but fears it could result in a US debt default weighed on world shares and oil.

A White House spokesman said on Monday it would accept a short-term increase in the nation's borrowing authority to avoid a default. An influential senator was also said to be floating a plan to cut federal spending and reform the US tax code as part of a broader deal.

As the partial US government shutdown enters a second week, most investors still believe Republicans and Democrats can reach deals on the budget and the debt ceiling. But worries they may fail were beginning to grow.

"In our opinion markets are a little too complacent. The downside risks are horrendous if there is no resolution and the debt ceiling is breached," said Kevin Corrigan, head of credit at Lombard Odier Investment Managers.

Banks and investors outside the US were also moving on Tuesday to ensure a steady supply of dollars to cover the critical mid-October period when the government hits the borrowing limit, paying sharply higher premiums in the forward foreign exchange market.

All the uncertainty kept the MSCI world equity index , which tracks shares in 45 countries, within a narrow range with US stock index futures pointing to a mixed start when trading on Wall Street opens later.

The stability of riskier assets in the face of the potential threat of a US debt default, which would spark massive turmoil on global financial markets, though has encouraged some investors to expect a big relief rally if a deal gets done.

"I'm prepared to step out at any time should it come crashing down, but for the moment I'm still betting on the upside," said Andreas Clenow, hedge fund trader and principal of Zurich-based ACIES Asset Management.

"Equities have held up remarkably well given what's going on. If that's not a strong sign, I don't know what is." Brent crude oil, another asset seen as a riskier investment, edged above its recent range of $109-$110 to $110.35 a barrel , although analysts said it could be gaining from the withdrawal of financial investors who wanted to sell.

"Oil is still doing surprisingly well, given the ongoing budget crisis in the US, the approach of the debt ceiling and mounting supplies," said a Commerzbank research note.

"Nevertheless, we suspect that the latest show of strength on the part of oil is only temporary." European equities traded lower after ending in negative territory for three of the last four trading sessions.

The broad FTSE Eurofirst 300 index dipped 0.5 % by midday. Earlier MSCI's broadest index of Asia-Pacific shares outside Japan reversed losses to gain 0.4 %, helped by a sharp rise in Chinese stocks on their first trading day in a week after the National Day holidays.

Dollar vulnerable
The dollar saw the main benefit from the signs lawmakers were taking steps to try to end the deadlock, gaining 0.5 % against the perceived safety of the yen to hit 97.20 yen .

Though this only took place after the greenback had dropped to 96.55 yen, its lowest since Aug. 12. The dollar index, which measures the US currency's value against a basket of currencies,, was still within striking distance of last week's eight-month low of 79.627 and traders said it remained vulnerable to further selling.

The longer the political deadlock runs, the greater the expected economic damage and the more likely it becomes that the Federal Reserve will continue for longer a stimulus programme that has flooded global markets with dollars.

America's biggest creditors, China and Japan, have also said they are increasingly worried that the developments in Washington could wreak havoc on their trillions of dollars of investments in US Treasury bonds.

"The risk is to the downside for the dollar as long as we don't have an agreement," said Niels Christensen, currency strategist at Nordea.

Gold gains
The US anxiety - and a broadly softer dollar - has helped support gold, which extended gains into a second day on Tuesday to trade up 0.2 % at $1,318 an ounce.

Gold also gained support from Chinese buyers returning after a week-long holidays. China is the world's second-biggest gold consumer after India.

The worries over the US fiscal impasse largely overshadowed data from China showing business confidence in the countries services sector had slipped in September though the economy remained on course for expansion.

Copper, which is very sensitive to Chinese data due to the country's heavy demand for the metal, was slightly firmer, up 0.2 % at $7,260 a tonne, though within the $7,000-$7,500 a tonne range seen since early August.