By Jane Foley, Senior FX Strategist at Rabobank
The closure of the US and UK markets in addition to parts of Europe yesterday meant it was tough for investors to fully express the impact of the events of the past few days. In the US, President Biden and House Speaker McCarthy finalised an agreement on Sunday that would raise the US debt ceiling for two years past the 2024 presidential election and curb government spending during that time. In Turkey, Erdogan secured a victory in the second round of the presidential election which takes his increasingly authoritarian rule into its third decade. In Spain, a resounding defeat for the Socialist party in regional and local elections led to a stony-faced PM Sanchez announcing that parliament would be dissolved on July 23 to make way for a snap general election. Rumours of a snap general election have also been growing in Japan, with reports of a possible ballot in the summer or in the autumn. PM Kishida’s approval ratings have been boosted following the recent G7 meeting and on the back of the thaw in bi-lateral relations with South Korea. On top of the politics, the market continues to focus on the possibility of further rate hikes from the Fed this cycle and on the disappointing pace of the recovery in China. The offshore yuan weakened beyond 7.1 per USD for the first time since November ahead of the release of Chinese PMI data later in the week.
The US debt ceiling deal must now be passed by Congress and signed into law. It appears that there is enough bi-partisan support but there are still obstacles to be cleared, the largest of which is likely to be the House. While some Progressives worry that the deal will short-change the most vulnerable in society, some Republicans are of the view that the budget cuts in the deal do not go far enough. The legislation goes before the House Rules Committee today and is expected to reach the House floor tomorrow. Treasury Secretary Yellen has warned of the possibility of default by June 5 unless the debt ceiling is raised.
The market had already been adjusting to the likelihood of a debt ceiling deal on Friday, but relief allowed US equity futures to hold in the green yesterday and overnight. Very short-dated T-bill yields have come off their recent highs and longer dated Treasury yields also fell. That said, the front end of the curve is likely to remain sensitive to speculation regarding the possibility of further Fed tightening. Friday’s release of stronger than expected PCE deflator data served to highlight this view. The headline measure rose to 4.4% y/y in April while the core edged up to 4.7% well above the Fed’s target for stable price pressures. The USD found support on these data on Friday and, while the DXY dollar index traded off its high yesterday, it has crept higher this morning.
Comments yesterday from the ECB’s De Cos that the tightening cycle in the Eurozone is closer to its end but still has a way to go, did little to alter the outlook for the EUR. The market is already prepared for further ECB rate hikes and, the likelihood that the region faces stagnation in H2 has been undermining the confidence of EUR bulls in recent weeks. News of Spain’s snap election comes just as the country is due to take over the EU’s rotating presidency. This suggests the bloc’s legislative process could be hindered for the remainder of the year. This could have implications for the proposals for new fiscal rules in member countries.
Press reports suggest that it was Putin who was the first leader to congratulate Erdogan in his win in the Turkish election. Despite Western concerns about Erdogan’s increasingly authoritarian rule, Putin was closely followed by Biden and Macron. Last year, Turkish imports from Russia grew considerably. That said, Turkey also carries considerably military might and is an important member of Nato. Along with Hungary, Turkey is continuing to block Sweden’s bid to join Nato which is cause of impatience at the White House. In addition to its crucial military position, Turkey held a critical role in European 2015 migration crisis with Erdogan’s government effectively being paid by the EU to prevent illegal migrants travelling from Turkish waters onward to Europe. For the market’s perspective, another term for Erdogan suggests a continuation of his unorthodox policies, though this depends on his new economic team which could be announced on Friday. The TRL has sunk to a new record low vs. the USD on the likelihood that Erdogan will keep a tight grip on the central bank, not to mention the media.