Global markets are primed for a relief rally after US negotiators agreed to a tentative deal over the weekend to resolve a debt crisis that has battered risk sentiment in recent weeks.
The US dollar, which has benefited from angst around the statutory borrowing limit, will be in focus as another week of trading begins at 5 a.m. Monday in Sydney. Liquidity is set to be thin with US and UK markets closed Monday for national holidays, although futures contracts referencing US Treasuries and the S&P 500 Index will trade.
Investors had flocked to safety in recent weeks as the so-called X-date — the day on which the Treasury expected it wouldn’t be able to meet all of its obligations — rapidly approached. House Speaker Kevin McCarthy said he will talk with President Joe Biden again on Sunday and line the bill up for a vote on Wednesday.
“Markets should breathe a sigh of relief, with the dollar likely to soften a tad as the debt ceiling imbroglio is finally resolved,” said Chang Wei Liang, a strategist at DBS Group Holdings in Singapore. “The deal appears well-balanced between reducing spending while not jeopardizing growth, and is likely to be a small positive for US Treasuries.”
Somewhat ironically, the prospect of a US default has been a boon for the dollar, with the US dollar advancing against all of its Group-of-10 peers this month.
The currency’s outperformance — steamrolling even the traditional safe-haven yen, which fell to six-month lows past 140 per dollar last week — reflects the US’s unique position at the center of the global financial system. Even when the nation is flirting with default, investors have little choice but to flock to dollar-denominated assets like Treasuries for protection.
An MLIV Pulse survey earlier this month showed US debt was second only to gold as the most popular asset to buy in the event of a default.
To be sure, Treasury market investors have remained optimistic about the prospects for a debt deal, with swap traders now pricing in about a quarter-point rate hike over the next two Federal Reserve policy meetings, implying the central bank will be able to retain its focus on fighting inflation.
Damage Done
The costs of weeks of political wrangling have already taken a toll. The US Treasury has paid $80 million more to issue bills in the wake of earlier warnings from Yellen about running out of cash, her deputy said Thursday. Wall Street watchers, meanwhile, say that a subsequent push by the government to refill its coffers in the wake of a deal will quickly drain liquidity from the banking system.
This will mean all the more pressure on US banks after months of turmoil. A deluge of bill supply could be another boost to the dollar, according to Bipan Rai, head of FX strategy at Canadian Imperial Bank of Commerce.
“We are becoming more sensitive to the view that greenback strength might be persistent given the deluge of bill supply once things settle and what that would mean for financial system liquidity,” Rai wrote in a note to clients last week.
--With assistance from Ruth Carson.