Global markets look primed for a relief rally after US negotiators agreed to a tentative deal over the weekend to resolve a debt crisis that has weighed on risk sentiment in recent weeks.
(Bloomberg) — Global markets look primed for a relief rally after US negotiators agreed to a tentative deal over the weekend to resolve a debt crisis that has weighed on risk sentiment in recent weeks.
American equity futures made modest gains after Friday’s strong showing on Wall Street, while Treasury futures were mixed in the absence of cash trading. The US dollar, which has benefited from angst around the statutory borrowing limit, erased an earlier loss amid thin liquidity, with US and UK markets closed for national holidays.
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. President Joe Biden and House Speaker Kevin McCarthy voiced confidence that their deal will pass Congress and reach the president’s desk for signature, averting a historic US default.
“Markets should breathe a sigh of relief,” 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.”
Treasury futures were mixed. Contracts referencing short-maturity debt were little changed, consistent with recently mounting expectations that the Federal Reserve is likely to raise interest rates again, if not in June then in July, as inflation remains unacceptably high. Futures linked to long-maturity Treasuries rallied, suggesting that 10- to 30-year yields will decline when cash trading resumes.
European government bonds gained, sending the yield on the 10-year German benchmark 10 basis points lower to 2.44%. That snapped five days of consecutive losses.
The extent of the relief rally may only emerge later this week once Congress has voted, particularly with many traders in US, UK and parts of Europe out of the office on Monday. Price moves also reflect position rebalancing into month-end.
“Market sentiment has generally remained constructive overnight, although investors will probably want to wait for the US debt deal to pass Congress before taking further exposure to risky assets,” UniCredit strategists wrote in a note.
The Australian dollar climbed 0.3%, paring last week’s 2% drop, the euro slipped and pound held steady. Somewhat ironically, the prospect of a US default has been a boon for the dollar, with the greenback advancing against all of its G-10 peers this month.
The currency’s outperformance — steamrolling even the 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.
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.
Still, next comes a push to shepherd the deal through Congress over the objections of hard-liners in both parties.
“While it’s still expected by financial markets that McCarthy and Biden will prevail in garnering enough votes, there’s still a lingering concern that there may be a need for further negotiation to win over the most unwavering critics,” said Quincy Krosby, chief global strategist for LPL Financial.
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, Matthew Burgess, Michael G. Wilson, Joanna Ossinger, Alice Gledhill, Elizabeth Stanton and Philip Sanders.
(Updates Treasury futures in second and fifth paragraphs.)
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