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25 May 2023,05:54

Weekly Outlook

Dollar Rises On Debt Ceiling Optimism And Hawkish Fed Tone

25 May 2023, 05:54

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The dollar has its highest since March as Fed meeting participants lean hawkish even as punters expect a hike pause in June. 

Important this week: the Fed meeting minutes released on Wednesday and more updates on the U.S. debt ceiling talks. 

The minutes for the Fed’s May 2-3 meeting was released yesterday, with divergent opinions from officials on whether rate hikes should continue. What has been confirmed though, is the general opinion that effects of the Fed’s aggressive tightening regime in the past 14 months are just beginning to show. 

“Participants generally expressed uncertainty about how much more policy tightening may be appropriate,” the minutes said, further emphasising that meeting participants preferred to wait for further indicators of cooling inflation, while keeping the option for future hikes open. Officials are leaning towards a pause in June to wait and see; while the CME’s Fedwatch tool shows a 67% bet on a hike pause with the other 33% betting on a 25-point hike. 

Predictably, the minutes also noted the catastrophic consequence of a U.S. default. Debt ceiling talks are still continuing, with no conclusion in sight even though both President Joe Biden and House Speaker Kevin McCarthy have expressed optimism at some point. As previous debt ceiling debates have shown, talks tend to drag up until the last minute until either side is forced to yield (or compromise)  – not to say that brinkmanship is not without consequences.

Dollar Following Debt Ceiling Closely

Optimism surrounding the talks have boosted the dollar, with the dollar index trading above 104 even with the Fed signalling a potential rate hike pause in the coming June meeting. Here’s the irony: while talks to raise US$31.4 trillion debt ceiling have continuously leapt between optimism and fear and resulted in short-term dollar volatility, the “king dollar” has been steadily on the uptrend in the past month on investors seeking safe haven from the very event that threatens (or does it) to derail the U.S. economy. 

Not Black And White

Here’s the thing to understand: the Treasury Secretary’s so-called X-date of 1 June is mostly symbolic as the exact date for a U.S. default would depend on tax revenue for May and June. 

The full consequences of the debt scenario is not absolutely dependent on the ceiling being raised by 1 June. Already, credit rating agency Fitch is threatening to downgrade the US’ AAA credit rating over the debt ceiling impasse, a move that will greatly impact the US bonds and equity markets. A downgrade will ostensibly increase borrowing costs and slow the economy – which might be exactly what the Fed is after. 

Investors are advised to look out for the US QoQ GDP figures for Q1, which will be released today at 15:30 (GMT+3). A significant slowdown to 1.1% is expected, down from last quarter’s 2.6%.

As a  friendly reminder, do keep an eye on market changes, control your positions, and manage your risk well.

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