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Debt Ceiling talks to dominate the week ahead

Commentaries & Views

Expect for the last full trading week of May to be dominated by nothing but US debt ceiling updates.

This is the drum that I would expect financial market sentiment to beat to throughout the week, especially as we edge nervously closer to the June 1 deadline where the United States might run out of money. Former Fed Chair and current Treasury Secretary Janet Yellen has referred to the prospect of the U.S defaulting as having catastrophic consequences.

As things stand, traders have not necessarily priced in an outcome that the ongoing pantomime in Washington could go down to the very wire as the clock is ticking and this means that markets are in line to encounter a nervous atmosphere as the week progresses with no resolution. In such a potential risk-off atmosphere, we can expect world markets and assets associated as risky such as Oil and emerging markets to trend weaker. On the other hand, the US Dollar and Japanese Yen are the prime contenders of assets of safety that traders will look for.       

This situation over the debt ceiling in the United States can very much still be classified as pantomime. The will they / won’t they question should ultimately lead to a resolution to the debt ceiling being found. Neither the Republican or Democratic party can afford to be blamed for the unbelievable global uproar the U.S running out of money would have, especially as we head into a year of United States Presidential Elections as a major event in 2024. 

The overall global financial markets view is that the United States will avoid defaulting.

Fed official comments to help EURUSD?

The trend of selling the Eurodollar from last week is in line to hopefully pause ahead of comments from the Fed on US interest rate policy expected for this week via the latest Fed Minutes release.

This week will see the latest Fed Minutes released, where investors will very much be hoping for some clarity from the Federal Reserve on the future outlook of US interest rate policy. Any comments indicating that the Fed is either concerned about the aggressive pace of US interest rate increases impacting the United States economy over the longer-term or confirmation that no more US interest rate hikes are likely can lead to a pause in the recent USD revival.

What can also help the EURUSD plant its feet at 1.08 is expectations that a divergence in monetary policy might actually be emerging in the ECB’s favour after years of the scale being tipped in the direction of the Fed. Should the Fed confirm that it is done with interest rate hikes or data releases from the United States suggest that is the case, hawkish comments from the likes of ECB President Christine Lagarde can present a helping hand to Eurodollar buyers.

We however must also take into account that a flurry of bids for the US Dollar should investors become nervous about narratives coming out of Washington can send the EURUSD sharply lower in a blink.  

USDTRY to find 20 imminently

It appeared to be only a matter of time once it was confirmed that the Turkish Presidential Elections would face a second round and that the current President was in the driving seat, but USDTRY is in line to find 20 at any moment.

This would mean that the Turkish Lira has weakened to 20 against the US Dollar for the first time ever, meaning another record-low for the Turkish currency. The reasoning behind the Lira reaching new all-time lows, no matter how much in vain the Central Bank of the Republic of Turkey battle against it through intervention in financial markets is because traders are pricing in the prospect of Erdogan staying in power.

Along with many other matters, the Turkish President has been an advocate of making public comments on central bank policy for years, including clear evidence of central bank independence being breached and central bank governors finding themselves suddenly replaced. Such events will continue should there be no change in President, with this explaining why the Turkish Lira continues to find new record-lows.

The Lira has weakened by more than 340% against the US Dollar over the last five years and more than ten times its value if we look at the past decade. USDTRY was valued at 1.85 as of 24 May 2013. This should be remembered as a lesson in textbooks for economic students for years to come when it comes to providing a recent case study on what impact central bank independence fears can have on your currency.

Think twice before expecting Gold to rally on debt ceiling updates

While the prospects of the United States defaulting are naturally bullish for Gold over the longer-term, potential nervous updates before the June 1 deadline will not necessarily lead to Gold aiming higher if the USD also surges.

We must remember that even though both Gold and the US Dollar are very much assets of safety, previous flashes of sudden rallies for the Greenback (such as the initial stages of covid) have unexpectedly been bad news for Gold.

This might also be the case this week should the US Dollar move higher as a result of concerning headlines from Washington. 

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