debt crisis

Rates Spark: Debt ceiling deal adds to bond angst A deal to raise the US debt ceiling increases selling pressure on Treasuries, but will also result in tighter financial conditions for the economy. This opens upside to EUR rates but a soggy economic backdrop means wider rate differentials near-term.   Once approved, the debt limit deal paves the way to a liquid crunch  The deal between President Biden and House leader McCarthy amounts to the removal of a tail risk for financial markets, that of a US default. Even if this was a tiny probability event to begin with, it'll allow markets to focus on the more important debate: whether the Fed is indeed done with its hiking cycle. The budget deal, which lifts the debt limit for two years and caps some categories of government spending, still needs to be approved by the House tomorrow.   The outcome of the vote is uncertain but the likely opposition by some Republicans means Democrat votes will be key. We expect the run-up to the vote to see Treasury Yields gradually climb higher if more lawmakers come out in favour of the deal.   Money markets can expect a $500bn liquidity drain over the coming months Beyond tomorrow, US rates will quickly look past the deal and turn their attention to the Treasury's task of rebuilding its cash buffer at the Fed. Two aspects matter here. On the liquidity front, money markets can expect a $500bn drain over the coming months as more debt is issued. In a context of $95bn/month Quantitative Tightening (QT) and of likely tightening of at least some banks' funding conditions, this should amount to an additional drag on financial conditions for the broader economy.   This should ultimately draw a line under the US Treasury selloff but, should the new borrowing come with an increase in maturity, some of that support may be weakened.   The case for a June hike has strengthened after Friday's higher than expected core PCE print and Treasuries are set to trade softly into Friday's jobs report as recent prints have demonstrated the labour market's resilience. 4% yield for 10Y now seems a more achievable level.   Weak European data prevents EUR rates from rising as fast as their US peers        

The ADP report on employment in the private sector, published a day before the non-farm payroll data release, was so shocking that it instantly raised expectations for the labor market as a whole, leading to rapid repositioning on Friday before the data release. However, the non-farm payroll figures were significantly weaker than expected, with 209,000 new jobs created (225,000 expected), and data for the previous two months were revised downwards by 110,000. Employment growth is slowing, but the pace remains high. As for wage growth, the figures were an unpleasant surprise for the Federal Reserve. In June, wages increased again by 0.4% instead of the expected 0.3%, and annual growth rates remained at 4.4%, which is higher than the 4.2% forecast. Steady wage growth does not allow inflation expectations to fall, the growth of real rates does not allow the Federal Reserve to start lowering the rate this year.       The U.S. inflation index, which will be published on Wednesday, is the main event of the week and the last important data before the Fed meeting at the end of July. The markets expect an 89% probability of a quarter-point rate hike. Furthermore, the probability of another increase in November has already exceeded 30%, and the first cut is now expected only in May of next year. The U.S. dollar fell after the data release and ended the week weaker than all G10 currencies. The growth of real rates in the current conditions makes a recession in the U.S. almost inevitable.   EUR/USD The Sentix Economic Index for the eurozone has fallen for the third time in a row to -22.5 points, a low since November 2022, and expectations also remain depressed. The eurozone economy has fallen into a recession as of early July. The situation in Germany is even more depressing – the index has fallen to -28.5 points, and the possibility of improvement is ephemeral.     The ZEW index will be published on Tuesday, and the forecast for it is also negative, with a decrease from -10 points to -10.2 points expected in July. On Thursday, the European Commission will present its forecasts. Bloomberg expects that industrial production in the eurozone fell in May from 0.2% y/y to -1.1% y/y, a sharp decline that characterizes the entire eurozone economy as negative and tending to further contraction.   Under the current conditions, the European Central Bank intends to continue raising rates, and even plans to shorten the reinvestment period of the PEPP program. If this step is implemented, a debt crisis, which will put strong bearish pressure on the euro, is inevitable in the face of capital outflows to the U.S. and an expanding recession.   The net long position on the euro has hardly changed over the reporting week and amounts to just over 20 billion dollars, positioning is bullish, there is no trend. However, the calculated price is still below the long-term average and is trending downward.     The euro attempted to strengthen on Friday in light of the news, but it was unable to rise beyond the borders of the technical figure "flag", let alone higher than the local high of 1.1012. We assume that the corrective growth has ended, and from the current levels, the euro will go down, the target is the lower boundary of the "flag" at 1.0730/50. GBP/USD Updated data on the UK labor market will be published on Tuesday. It is expected that the growth of average earnings including bonuses increased in May from 6.5% to 6.8%, and if the data comes out as expected, inflation expectations will inevitably rise. As will the Bank of England's peak rate forecasts. The NIESR Institute expects that further rate increases could trigger a recession.   The cost of credit is rising, and an increase in the volume of bad debts is inevitable in an economic downturn. Inflation did not decrease in May, contrary to expectations, and remained at 8.7%, even though energy prices significantly decreased. Food inflation on an annual basis reached 18.3%, and core inflation at 7.1% is at its highest since 1992. The labor force is decreasing, and if this trend is confirmed on Tuesday, it will almost inevitably result in increased competition for staff, which will mean, among other things, the continuation of wage growth. The Bank of England has already raised the rate to 5%, with forecasts implying two more increases. What does the current situation mean for the pound?   If the economy can keep from sliding into a recession, then in conditions of rising nominal rates, the yield spread will encourage players to buy assets, leading to increased demand for the pound and its strengthening. However, if signs of recession intensify, which could be clear as soon as Thursday when GDP, industrial production, and trade balance data for May will be published, the pound will react with a decrease, despite high rate expectations. After impressive growth two weeks ago, pound futures have stalled at achieved levels, a weekly decrease of just over 100 million has no significant impact on positioning, which remains bullish.