Traders Embrace Riskier Assets After The Debt-Cap Deal

Global markets are poised for a relief rally following the agreement of US negotiators on a tentative deal over the weekend to address the ongoing debt crisis that has significantly impacted risk sentiment in recent weeks.

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As the new week of trading begins, the focus will be on the US dollar, which has benefited from concerns surrounding the statutory borrowing limit. Trading activity is expected to be subdued due to US and UK markets being closed on Monday for national holidays. However, futures contracts referencing US Treasuries and the S&P 500 Index will still be available for trading.

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In recent weeks, investors had sought safety as the X-date, the day when the Treasury anticipated being unable to fulfill all its obligations, drew closer. House Speaker Kevin McCarthy has indicated that he will have discussions with President Joe Biden on Sunday, and the bill will be lined up for a vote on Wednesday.

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"Markets should find relief as the debt ceiling issue is finally resolved, leading to a slight softening of the dollar," said Chang Wei Liang, a strategist at DBS Group Holdings in Singapore. "The deal seems to strike a balance between reducing spending without jeopardizing growth and is likely to have a mildly positive impact on US Treasuries."

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Ironically, the potential for a US default has bolstered the dollar, causing it to outperform its Group-of-10 counterparts this month. This exceptional performance, surpassing even the traditionally safe-haven yen, reflects the US's central position in the global financial system. Even in times of potential default, investors have limited options but to turn to dollar-denominated assets such as Treasuries for protection.

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An MLIV Pulse survey conducted earlier this month revealed that US debt was the second most popular asset, after gold, to invest in the event of a default.

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Nevertheless, Treasury market investors have maintained optimism regarding the prospects of a debt deal. Swap traders are now pricing in a quarter-point rate hike over the next two Federal Reserve policy meetings, indicating that the central bank can continue to focus on combating inflation.

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The prolonged political disputes have already had consequences. The US Treasury has incurred an additional $80 million in costs for issuing bills due to previous warnings from Treasury Secretary Janet Yellen about running out of cash, as mentioned by her deputy. Moreover, analysts on Wall Street suggest that the government's subsequent efforts to replenish its coffers after reaching a deal will quickly drain liquidity from the banking system.

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This will exert additional pressure on US banks, which have already faced months of turmoil. The influx of bill supply could further bolster the dollar, according to Bipan Rai, the head of FX strategy at the Canadian Imperial Bank of Commerce.

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"We are increasingly mindful of the possibility that the strength of the greenback may persist given the surge in bill supply once the situation stabilizes, and the implications it would have on financial system liquidity," Rai wrote in a note to clients last week.

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