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US debt ceiling: two steps forward, 1 step back

• US debt ceiling. Talks hit an impasse. Negotiations set to resume later today. A deal is needed quickly with the ‘x-date’ coming closer into view.
• AUD sluggish. Global forces will continue to drive the AUD. Beyond the debt ceiling, the global economy is slowing. This is normally a headwind for the AUD.
• RBNZ hike. AUD/NZD has slipped below 1.06. RBNZ meets on Wednesday. Following the NZ Budget expectations of another ‘hawkish hike’ have risen.

Optimism regarding a US debt ceiling deal faded a bit on Friday, with negotiations reaching an impasse. US equities lost some ground (S&P500 -0.1%), while the US 2-year bond yield (-2bps to 4.26%) and the USD Index eased back modestly after Fed Chair Powell appeared to express a preference for a ‘pause’ in the rate hiking cycle in June. Chair Powell noted that settings were ‘restrictive’ and that the aggressive steps already taken means that policymakers “can afford to look at the data”.

In terms of the debt ceiling, after earlier signs of progress, talks broke down with the two sides remaining apart on key issues. It is reported that the Republicans are continuing to push for sizeable government spending cuts, particularly in areas such as healthcare, education, and housing, while also maintaining the Trump-era corporate tax cuts. The two sides agreed to resume talks with President Biden and House Speaker McCarthy set to meet on Monday. The clock is ticking for a deal to be reached to raise the US debt ceiling. The estimated ‘x-date’ (i.e. when the US won’t be able to pay an upcoming obligation) is coming closer into view. US Treasury Secretary Yellen has indicated that the ‘x-date’ could be as soon as 1 June. As our chart shows, the 1-month US TED spread (i.e. the difference between the yield on US Government and Corporate debt) is in negative territory, implying that nervous participants are demanding a higher premium to hold US government debt over the next month due to the greater perceived chance of a default.

Debt ceiling negotiations are set to dominate the headlines this week and can be a source of volatility. In our view, the closer the ‘x-date’ approaches without a deal, the higher anxiety levels (and volatility) could go. This is normally a backdrop that favours currencies like the USD, JPY, and EUR over cyclical ones such as the AUD.

Beyond the US debt ceiling negotiations, the data focus this week will be on the European and US PMIs (Tues) and the US PCE deflator (Friday). The PCE is the US Fed’s preferred inflation gauge. We think the core PCE deflator is likely to remain at uncomfortably high levels and show that progress back down to the Fed’s inflation target is slow going. Assuming a debt ceiling deal is reached, we believe the US Fed is unlikely to crystallise market pricing looking for ~2-3 rate cuts by January. In our view, a further paring back of these rate cut expectations is likely to be USD supportive.

Global event radar: Eurozone & UK PMIs (Tues), RBNZ Meeting (Weds), US PCE Deflator (Fri), China PMIs (31st May), Eurozone CPI (1st June), US Jobs Report (2nd June), RBA Meeting (6th June), Bank of Canada Meeting (8th June).

AUD corner

The AUD found a bit of support on Friday, with the impasse in the US debt ceiling negotiations offset by the slight dip in US bond yields and the USD following comments by Fed Chair Powell pointing to a ‘pause’ in rate hikes in June. That said, at ~$0.6650 the AUD remains near the bottom end of its ~3-month range. We continue to think that near-term AUD upside is likely to be limited, with downside pressures still firmly in place as global forces continue to dominate.

The local data calendar is limited this week, with April retail sales (due Friday) the only release of note. Globally, attention will remain on the US debt ceiling talks, particularly as the ‘x-date’ (i.e. when the US won’t be able to pay an upcoming obligation) is approaching. Some estimates put this as early as 1 June. In our judgement, the longer the talks go without a deal being agreed, the higher market nerves and volatility could rise. This is normally an environment which is a headwind for the AUD given its elevated correlation to risk sentiment.

On the assumption that a debt ceiling deal is reached, we doubt any knee-jerk lift in the AUD will extend too far. Fundamentally, the global economy is slowing, with China’s post lockdown recovery faltering. As our chart shows, global economic data surprises have fallen back into negative territory. We expect the global downturn to intensify over the next few months as tighter credit conditions constrain activity, which in turn should be a drag on commodity demand. And in the US, as discussed above, we think that pricing for multiple rate cuts by the US Fed over H2 is unlikely to materialise given the US’ inflation problem. A further reduction of US rate cut bets should, in our judgement, be a USD positive.

On the crosses, AUD/NZD has slipped back below ~1.06 with relative interest rate expectations moving further in favour of the NZ following some strong migration numbers and last week’s stimulatory NZ budget. The RBNZ meeting is in focus this week (Wednesday). The debate is whether the RBNZ delivers a 25bp or 50bp hike. We think a 25bp rise is more likely, which would take the OCR up to 5.5%, however a larger move can’t be ruled out as we believe the fiscal picture means that the aggressive RBNZ could have more work to do to tame inflation. Another hike and ‘hawkish’ rhetoric should, in our opinion, continue to keep the pressure on AUD/NZD in the near-term.

AUD event radar: Eurozone & UK PMIs (Tues), RBNZ Meeting (Weds), AU Retail Sales (Fri), US PCE Deflator (Fri), AU CPI (31st May), China PMIs (31st May), Eurozone CPI (1st June), US Jobs Report (2nd June), RBA Meeting (6th June), AU GDP (7th June), RBA Gov. Lowe Speaks (7th June), Bank of Canada Meeting (8th June).

AUD levels to watch (support / resistance): 0.6565, 0.6620 / 0.6687, 0.6712

SGD corner

USD/SGD has consolidated up near ~$1.3460, the top end of its two-month range. As discussed above, the US debt ceiling negotiations look to have hit a stumbling block. Talks are set to recommence today, with a deal needing to be struck rather quickly given the ‘x-date’ (i.e. when the US won’t be able to pay an upcoming obligation) fast approaching. The US debt ceiling negotiations will be in focus this week. In our view, the longer the talks draw out without a deal, the more nervous markets could become, and this is normally a backdrop that is supportive for the USD, and JPY over Asian currencies like the SGD. On the assumption an agreement is reached, we expect the market focus to return to the US Fed’s inflation fight. And based on the still high/sticky US inflation pulse, we believe that market pricing looking for ~2-3 rate cuts by January is misplaced. A further shift up towards a ‘higher for longer’ outlook is likely to provide the USD (and USD/SGD) with a bit more of a boost, in our opinion.

SGD event radar: Singapore CPI (Tues), Eurozone & UK PMIs (Tues), US PCE Deflator (Fri), China PMIs (31st May), Eurozone CPI (1st June), US Jobs Report (2nd June), RBA Meeting (6th June), Bank of Canada Meeting (8th June).

SGD levels to watch (support / resistance): 1.3337, 1.3377 / 1.3500, 1.3540

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