Traders brace for volatility as a US debt deal remains elusive

(Bloomberg) — Investors are bracing for higher currency volatility and stock losses as the United States struggles to reach a deal to reduce debt.

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The dollar was trading in narrow ranges against its major peers as of 6 am in Sydney as market participants assessed recent developments. House Speaker Kevin McCarthy said he and President Joe Biden will meet Monday afternoon, and negotiators will resume debt talks later Sunday. The Republican leader said he and Biden, returning from a Group of Seven summit in Japan, had a “productive” invitation. “Time is of the essence,” McCarthy added. Treasury Secretary Janet Yellen said on NBC’s Meet the Press that the United States is unlikely to make it to mid-June and still be able to pay its bills.

The debt ceiling debate has become an unwelcome side-show for investors already dealing with the uncertainty surrounding the Fed’s next policy decision in June. Strategists at JPMorgan Chase & Co. and Morgan Stanley have warned that the impasse threatens the outlook for equity markets, while traders also pile into major currency swaps and options to hedge their portfolios. European Central Bank President Christine Lagarde appealed to US politicians to resolve the crisis in a television interview broadcast on Sunday.

“Despite the encouraging headlines, history suggests that regulators will take things backwards, which will add to market volatility,” said Carol Kong, strategist at the Commonwealth Bank of Australia in Sydney. “If and once a deal is reached, the focus will quickly shift to economic data and the FOMC, which I think should lead to more modest gains for the dollar.”

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The inconsistency between lawmakers has Wall Street bracing for the worst, as trade, corporate and consumer banking executives at the country’s three largest lenders try to predict how the government will fail to pay the bills across the markets. Some look to 2011, when a similar episode led to massive price swings across asset classes.

However, investors may not be ready. About 71% of respondents in a recent Bank of America survey expect a decision before the so-called X-date, the point at which the government exhausts financing options for itself, though not necessarily entering a default.

The S&P 500 rose last week, hoping that a solution is soon. A measure of the dollar’s strength touched a two-month high, boosted by safe-haven demand and strong expectations for Fed increases.

Yen, stock bets

In addition to US assets, the yen, commodity currencies and emerging market equities sensitive to swings in risk sentiment are also under close scrutiny. The yen was little changed against the dollar in early Asian trading while commodity currencies traded mixed against the greenback.

Goldman Sachs says the looming US debt ceiling is a “reasonable catalyst” for the blows to economic growth and stock markets.

“The emerging market model is straightforward: large export markets, such as Korea, Mexico and Taiwan, tend to underperform the most,” strategists including Cesare Massri wrote in a note.

— with assistance from Michael G Wilson.

(Updates as currency trading begins in the second paragraph.)

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