Global markets set for relief rally after debt deal

Global markets are set for a relief rally after U.S. negotiators reached a tentative agreement over the weekend to end a debt crisis that has battered risk sentiment in recent weeks.

The US dollar, which has benefited from angst around the statutory borrowing limit, will be in focus as another week of trading begins Monday in Sydney. Liquidity is set to be thin, with the US and UK markets closed Monday for national holidays, although futures contracts referencing US Treasuries and the S&P 500 Index will trade.

Investors had flocked to safety in recent weeks as the so-called X-date, the day when the Fed expected it would not be able to meet all of its obligations, quickly approaching. House Speaker Kevin McCarthy said he would talk with President Joe Biden again on Sunday and line up the bill for a vote on Wednesday.

Markets should breath a sigh of relief, with the dollar likely to soften a tad as the debt ceiling imbroglio is finally resolved, said Chang Wei Liang, a strategist at DBS Group Holdings in Singapore. The deal appears well-balanced between reducing spending and not jeopardizing growth, and is likely to be a small positive for US Treasuries. The prospect of a US default has been a boon for the dollar, with the US dollar advancing against all of its Group of 10 peers this month.

The currency's outperformance - steamrolling even the traditional safe-haven yen, which dropped to six-month lows past 140 per dollar last week - shows the US's unique position at the center of the global financial system. Even when the nation's defaults occur, investors have little choice but to flock to dollar-denominated assets like Treasuries for protection.

In a recent survey, the MLIV Pulse survey revealed that US debt was second only to gold as the most popular asset to buy in the event of a default.

To be certain, investors of the Treasury market have remained optimistic about the prospects for a debt deal, with trade traders now pricing in about a quarter-point rate hike over the next two Fed policy meetings, indicating that the central bank will be able to maintain its focus on fighting inflation.

The expenses of weeks of political wrangling have already taken a toll. The US Treasury has paid $80 million more to issue bills, following earlier warnings from Yellen about running out of cash, her deputy said Thursday. Wall Street watchers say a subsequent push by the government to refill its coffers in the wake of a deal will quickly drain liquidity from the banking system.

This will mean more pressure on US banks after months of turmoil. A deluge of bill supply could be another boost to the dollar, according to Bipan Rai, head of FX strategy at Canadian Imperial Bank of Commerce.

We are becoming more sensitive to the view that greenback strength might be persistent given the deluge of bill supply once things settle and what that would mean for financial system liquidity, Mr. Rai said in a note to clients last week.

In the field widening, nothing Trump does appears to have a say on the GOP tightening.