Traders brace for volatility with US debt deal still elusive

(Bloomberg) — Investors are watching for spikes in currency volatility and losses in stocks as the U.S. struggles to reach a deal on the debt ceiling.

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The dollar traded in tight intervals in relation to its main counterparts at 06:00 in Sydney as market participants evaluated the latest 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, who is returning from the G-7 summit in Japan, had a “productive” conversation. “Time is of the essence,” McCarthy added. Treasury Secretary Janet Yellen said on NBC̵[ads1]7;s Meet the Press that the United States is unlikely to reach mid-June and still be able to pay its bills.

The debt ceiling debate has become an unwanted sideshow for investors already dealing with the uncertainty surrounding the Federal Reserve’s next policy decision in June. Strategist at JPMorgan Chase & Co. and Morgan Stanley have warned that an impasse threatens the outlook for equity markets, while traders have also piled into swaps and options on major currencies to hedge their portfolios. European Central Bank President Christine Lagarde appealed to US politicians to resolve the conflict in a television interview broadcast on Sunday.

“Despite encouraging headlines, history suggests that lawmakers will take things in their stride, which will add to market volatility,” said Carol Kong, strategist at Commonwealth Bank of Australia in Sydney. “If and when a deal is reached, the focus will quickly shift back to economic data and the FOMC, which I believe will lead to further modest dollar gains.”

The back-and-forth between lawmakers has Wall Street bracing for the worst, with trade, corporate and consumer banking executives at the nation’s three biggest lenders trying to predict how the government’s failure to pay bills will cascade through markets. Some look back to 2011, when a similar episode led to massive price swings across asset classes.

Still, investors may be underprepared. About 71% of respondents to a recent Bank of America survey expect a solution before the so-called X date, the point at which the government uses its options to finance itself, but without necessarily entering a default.

The S&P 500 rose last week on hopes that a solution is near. A gauge of the dollar’s strength hit a two-month high, boosted by demand for ports and stronger expectations for Fed hikes.

Yen, bets on stocks

In addition to US assets, the yen, commodity currencies and emerging market stocks that are sensitive to changes in risk sentiment are also under close scrutiny. The yen was little changed against the dollar in early Asian trade, while commodity currencies were quoted mixed against the dollar.

Goldman Sachs Group Inc. says the looming U.S. debt ceiling is a “plausible catalyst” for hits to economic growth and stock markets.

“The EC template is quite simple: major export markets, such as Korea, Mexico and Taiwan, tend to underperform the most,” strategists including Caesar Maasry wrote in a note.

–With assistance from Michael G. Wilson.

(Updates with the start of currency trading in the second section.)

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