Investing 28-05-2023 10:05 18 Views

US debt ceiling raised after White House and Republicans reach tentative deal

After weeks of negotiating a deal to raise the debt limit to avert default, Democrats and Republicans announced a tentative deal has been reached. The plan is to put it to vote on Wednesday, but the optimism is there, and one can assume that from now on, the only thing to work on is details.

As I explained in this article, failure to raise the debt limit would have had tremendous negative implications for the US economy and financial markets. However, there was no precedent for not raising the debt limit, so, in the end, the outcome was the most logical one.

Why did the negotiations take so long?

Negotiating on the debt ceiling deal might be viewed as a strategy. The uncertainty created by not knowing if the US will be able to pay its debt usually sends people out of stocks and into bonds.

By buying bonds, the yields decline, thus making it more desirable for the US to issue new debt at a lower cost.

Here is the concept, explained a few years ago by non-other than the current Fed Chair, Jerome Powell:

Jerome Powell said the quiet part out loud back in 2011.

When they pass the debt ceiling the U.S. government needs to create chaos in Europe & the stock market, driving up demand for the newly issued government bonds.

This has always been the plan 🤫https://t.co/i5igwygzVo https://t.co/UO3NJdamz6 pic.twitter.com/PewNKsAEz7

— Financelot (@FinanceLancelot) May 27, 2023

What are the implications for financial markets?

The financial markets should love the agreement. The idea that the US would default on its debt, however unlikely it was, weighed on the stock market.

Therefore, at Monday’s opening, the first thing to see is the future to tick higher in a risk-on environment.

Such an environment should also trigger an upside reaction in some currency pairs, such as EUR/USD, AUD/USD, or NZD/USD. Also, the JPY crosses, such as AUD/JPY or EUR/JPY, should react too by making new highs when compared to Friday’s closing levels.

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