Traders set to embrace riskier assets after debt cap deal

(Bloomberg) – Global markets are poised for a relief rally after U.S. negotiators agreed to a tentative deal over the weekend to resolve a debt crisis that has rattled risk sentiment in recent weeks .

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The US dollar, which benefited from angst over the statutory borrowing limit, edged lower against most Group of 10 peers as trading began in Sydney. Liquidity is expected to be thin on Monday as US and UK markets are closed for the bank holiday, although US Treasury and S&P 500 index futures are trading.

Investors had flocked to safety in recent weeks as the so-called X date – the day when the Treasury expected it would not be able to meet all of its obligations – rapidly approached. President Joe Biden and House Speaker Kevin McCarthy have expressed confidence that their deal will pass Congress and reach the president’s desk for signature, avoiding a historic US default.

“Markets should breathe a sigh of relief,” said Chang Wei Liang, strategist at DBS Group Holdings in Singapore. “The deal looks well balanced between cutting spending without compromising growth, and is likely to be a small upside for US Treasuries.”

Ironically enough, the prospect of a US default has been a boon for the dollar, with the US dollar rising against all of its Group of 10 peers this month.

The currency’s outperformance – driving even the traditional safe-haven yen, which fell to a six-month low past 140 to the dollar last week – reflects the United States’ unique position at the center of the global financial system. Even when the nation is flirting with default, investors have no choice but to rush into dollar-denominated assets like treasury bills for protection.

An MLIV Pulse survey earlier this month showed that US debt was second only to gold as the most popular asset to buy in the event of default.

To be sure, Treasury market investors remained optimistic about the prospects for a debt deal, with swap traders now expecting rates to rise by around a quarter point in the next two Federal Reserve policy meetings. , implying that the central bank will be able to maintain its focus on fighting inflation.

Damage caused

The costs of weeks of political wrangling have already taken their toll. The U.S. Treasury paid an additional $80 million to issue bills following Yellen’s earlier warnings about a shortage of money, his deputy said Thursday. Wall Street watchers, meanwhile, say a subsequent push by the government to fill its coffers following a deal will quickly drain liquidity from the banking system.

This will mean even more pressure on US banks after months of turbulence. According to Bipan Rai, head of foreign exchange strategy at the Canadian Imperial Bank of Commerce, a deluge of notes could be another boost for the dollar.

“We are becoming increasingly sensitive to the idea that greenback strength could be persistent given the deluge of bills once things settle down and what that would mean for liquidity in the financial system,” wrote Rai in a note to clients last week.

–With help from Ruth Carson and Matthew Burgess.

(Updates with currency movements in the second paragraph, the optimism deal will pass Congress in the third.)

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