Underestimate the US shutdown at your peril

Extreme caution is the name of the game as the world's largest economy begins a partial government shutdown.

Today has confirmed the Australian stock market wants to head north after it responded aggressively to a snippet of positive news against a backdrop of extreme uncertainty.

It looks like the Australian market is underestimating the impact of any prolonged US government shutdown on the global economy.

Today's partial shutdown, after failure to reach an agreement on the budget, has huge implications for the US economy if sustained. It is estimated the pay checks of 800,000 federal employees are at risk. Not a good sign for an economy in which consumption makes up 70 per cent of GDP.

This alone should be enough for investors to sit on the sidelines. For one day - at least.

Today is evidence of just how politically fragile the US is. It is a scary thought that these two political parties are ultimately holding a loaded gun to global growth by not being able to reach a budget resolution. If you need reminding of the market's take on the influence the US has on global growth, just remember how it rallied after the Federal Reserve decided not to taper stimulus.

Data-wise today there was a surge in Australia's September Performance of Manufacturing Index (PMI) and retail sales beat expectations, spurring the S&P/ASX 200 index to a 40-point turnaround in only a matter of minutes around lunchtime. Investors were seemingly euphoric that economic data was slowly beginning to catch up with what the market has already priced in.

Not so fast. These latest economic numbers are really only just catching up to a market that has been recently looking overvalued. Today sees the recent trend reverse, by having the market value (white line) above price earnings expectations (green line).

Graph for Underestimate the US shutdown at your peril

An intraday swing was a remarkable effort considering investors were waiting for an update from the US government on whether they were shutting down, as well as an update from the RBA on monetary policy. What happens during the day is just as important as the final reading at market close.

Before getting giddy on September PMI numbers, remember it is only the first reading above 50 in over 2 years, indicating it is very much in the early stages of an expansion. A lower exchange rate, along with benign borrowing rates and renewed confidence following a change of government, are the driving forces behind the surge.

While interest rates will remain at current levels for now, the exchange rate is an entirely different story. The United States' ongoing quantitative easing and interest rates of 2.5 per cent will only provide scope for the Aussie dollar to appreciate once again against the US dollar.

What happens in the US economy unavoidably does impact us. Now is not the time to throw caution to the wind.