The event to watch for this week is ongoing negotiations over the US debt ceiling. Expect news to come right before June 1. Markets are likely to get more agitated in the meantime, with volatility futures predicting as much.
Comments from Powell increased an increased inclination towards a pause in hikes, but this is conditional on further economic weakness.
Further data from China suggest that weakness from the previous week was not a fluke, and foreign investors are increasingly coming to realise that China’s trajectory emerging from COVID is very different from the economic miracle we have seen in the past few decades. While it is not the dominant story currently, recession risks are increasingly real and apparent, and will likely be the next focal point for investors after the US debt ceiling resolves.
US Debt Ceiling
With Yellen’s June 1 deadline fast approaching, it’s crunch time for a deal out of DC. Frankly, a solid deal from the two sides was unlikely to emerge until right before the deadline, and the markets have reacted accordingly. Even as the days tick by, markets have been by and large stolid, with expectation for a last minute deal being priced in from the start. From the perspective of the politicians in question, every day before the last is an opportunity to pressure the other side. Either side could close negotiations at any time by caving to opposing terms, but why do that when each day is an opportunity to pressure the other, with the first to make concessions the loser of the two? Markets have thus been sensitive to signs of clarity of communication between the two sides, that discussions are ongoing. The main risk right now is a mistake close to the edge, where a miscalculation occurs and negotiations take just a tad too long.
With US Treasuries (UST) representing a massive portion of global fixed income and one of the default ways to hold USD in any quantity, a potential default is dangerous. There may currently be a slight market dislocation, and thus opportunity, in US Treasuries and its CDS given that many of the largest UST holders have a mandate to control their exposure to the apparent risk of a US default. There is also the point to be made that even if a payment is missed, UST holders are likely to be made whole eventually. What a technical default would look like to the global markets remains an open question.
Upcoming Calendar Events
- FOMC meeting minutes (24 May)
- US GDP, initial jobless claims (25 May)
- US PCE, Durable goods data, personal income and spending (26 May)
- US Treasury x-date (1 Jun)
- EU inflation data (1 Jun)
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