EUR USD - FUNDAMENTAL ANALYSIS
Foreign exchange analysts at Credit Agricole suggest that while uncertainty surrounding the US debt ceiling has been a key factor impacting the US Dollar (USD) recently, a resolution could potentially pave the way for a more sustainable recovery of the currency.
The recent ambiguity associated with the US debt ceiling - which is a legislative limit on the amount of national debt that can be incurred by the US Treasury - has had a substantial negative impact on the value of the US dollar (USD).
This is happening even as the US Congress, the legislative branch of the country, persistently works to avert a situation of sovereign default.
A sovereign default is a failure by a government to repay its country's debts, which could cause a financial crisis. The concern is that if the debt ceiling isn't raised or suspended, the US might reach a point where it can't meet its financial obligations, which creates uncertainty in the markets and can not only cause a recession but also weaken the USD.
"The uncertainty surrounding the US debt ceiling has been a key drag on the USD in recent weeks even as attempts to avert a sovereign default continue in the US Congress," says Valentin Marinov, Head of G10 FX Strategy at Credit Agricole.
He suggests a resolution to this issue could be reached ahead of the so-called 'x-date', the point at which the US Treasury would run out of funds to meet its financial obligations.
"We believe that a resolution – in the shape and form of either a debt ceiling extension or suspension – could be reached ahead of the ‘x-date’," he adds.
Regarding the X-date, economists at Barclays believe this date is estimated to be between 4-12 June (as of May 14).
"We estimate the Treasury’s x-date – or the point at which it runs out of cash and extraordinary measure capacity – is between June 4-12 • As of May 12, the Treasury had 230bn in remaining borrowing capacity."
Treasury Secretary Yellen noted, “...we still estimate that Treasury will likely no longer be able to satisfy all the government’s obligations if Congress has not acted to raise or suspend the debt limit by early June, and potentially as early as June 1."
USD Performance and The Debt Ceiling: Historical Perspectives and Forecasts
Marinov provides a historical analysis of the USD's performance surrounding past debt-ceiling episodes, dating back to 1993.
According to the analyst, the major declines seen in the US Dollar occurred against gold, the Japanese Yen (JPY), and the Swiss Franc (CHF).
In contrast, the U.S. Dollar held firm against the British Pound (GBP), New Zealand Dollar (NZD), Australian Dollar (AUD), Swedish Krona (SEK), and Norwegian Krone (NOK).
"Our results suggest that the USD losses were the most pronounced vs gold, the JPY and CHF. At the same time, the USD was broadly flat and even slightly stronger on average vs GBP, NZD, AUD, SEK and NOK," says Marinov.
Historically, the US currency has gained strength following most debt ceiling resolutions.
"We further conclude that the USD gained strongly across the board following most debt ceiling resolutions since 1993. In that, only gold was able to hold its ground while the NOK, SEK and GBP were the biggest underperformers on average," he adds.
The Prospect of a US Recession and Its Impact on USD
Drawing on the forecasts of Credit Agricole's US economist, Marinov points to the potential for a US recession in the second half of 2023.
He suggests that during periods when debt ceiling issues coincide with a US recession, as was the case in 2008 and 2009, the USD has emerged as the best performing G10 currency.
Marinov believes this could serve as a relevant template for the FX markets if the debt ceiling is only temporarily extended or suspended until September.
"Furthermore, our US economist expects the US to slip into a recession in H223. We thus note that the USD has emerged as the best performing G10 currency when debt ceiling episodes coincided with a US recession as was the case in 2008 and 2009," says Marinov.
Considering a Potential US Sovereign Downgrade
Marinov recalls the single instance of a US downgrade, by S&P following the 2011 debt ceiling episode, and points out that despite the downgrade, the US Dollar exchange rates managed to near-term recoup losses following the resolution.
"To date, there has been only one US downgrade – by S&P in the wake of the 2011 debt ceiling episode. The downgrade did not prevent the USD from regaining ground in the months following the resolution," says Marinov.
Furthermore, he expresses the view that while a failure to resolve the debt ceiling issue, leading to a US default, remains a very unlikely outcome, it could potentially fuel extreme market volatility.
Such a situation could boost the USD and US Treasury securities, given their unparalleled liquidity.
"Last but not least, a potential failure to resolve the debt ceiling issue and a US default remains a very unlikely outcome in our view that could nevertheless fuel extreme market volatility and thus support the USD and USTs given their unparalleled liquidity," he adds.
The recent ambiguity associated with the US debt ceiling - which is a legislative limit on the amount of national debt that can be incurred by the US Treasury - has had a substantial negative impact on the value of the US dollar (USD).
This is happening even as the US Congress, the legislative branch of the country, persistently works to avert a situation of sovereign default.
A sovereign default is a failure by a government to repay its country's debts, which could cause a financial crisis. The concern is that if the debt ceiling isn't raised or suspended, the US might reach a point where it can't meet its financial obligations, which creates uncertainty in the markets and can not only cause a recession but also weaken the USD.
"The uncertainty surrounding the US debt ceiling has been a key drag on the USD in recent weeks even as attempts to avert a sovereign default continue in the US Congress," says Valentin Marinov, Head of G10 FX Strategy at Credit Agricole.
He suggests a resolution to this issue could be reached ahead of the so-called 'x-date', the point at which the US Treasury would run out of funds to meet its financial obligations.
"We believe that a resolution – in the shape and form of either a debt ceiling extension or suspension – could be reached ahead of the ‘x-date’," he adds.
Regarding the X-date, economists at Barclays believe this date is estimated to be between 4-12 June (as of May 14).
"We estimate the Treasury’s x-date – or the point at which it runs out of cash and extraordinary measure capacity – is between June 4-12 • As of May 12, the Treasury had 230bn in remaining borrowing capacity."
Treasury Secretary Yellen noted, “...we still estimate that Treasury will likely no longer be able to satisfy all the government’s obligations if Congress has not acted to raise or suspend the debt limit by early June, and potentially as early as June 1."
USD Performance and The Debt Ceiling: Historical Perspectives and Forecasts
Marinov provides a historical analysis of the USD's performance surrounding past debt-ceiling episodes, dating back to 1993.
According to the analyst, the major declines seen in the US Dollar occurred against gold, the Japanese Yen (JPY), and the Swiss Franc (CHF).
In contrast, the U.S. Dollar held firm against the British Pound (GBP), New Zealand Dollar (NZD), Australian Dollar (AUD), Swedish Krona (SEK), and Norwegian Krone (NOK).
"Our results suggest that the USD losses were the most pronounced vs gold, the JPY and CHF. At the same time, the USD was broadly flat and even slightly stronger on average vs GBP, NZD, AUD, SEK and NOK," says Marinov.
Historically, the US currency has gained strength following most debt ceiling resolutions.
"We further conclude that the USD gained strongly across the board following most debt ceiling resolutions since 1993. In that, only gold was able to hold its ground while the NOK, SEK and GBP were the biggest underperformers on average," he adds.
The Prospect of a US Recession and Its Impact on USD
Drawing on the forecasts of Credit Agricole's US economist, Marinov points to the potential for a US recession in the second half of 2023.
He suggests that during periods when debt ceiling issues coincide with a US recession, as was the case in 2008 and 2009, the USD has emerged as the best performing G10 currency.
Marinov believes this could serve as a relevant template for the FX markets if the debt ceiling is only temporarily extended or suspended until September.
"Furthermore, our US economist expects the US to slip into a recession in H223. We thus note that the USD has emerged as the best performing G10 currency when debt ceiling episodes coincided with a US recession as was the case in 2008 and 2009," says Marinov.
Considering a Potential US Sovereign Downgrade
Marinov recalls the single instance of a US downgrade, by S&P following the 2011 debt ceiling episode, and points out that despite the downgrade, the US Dollar exchange rates managed to near-term recoup losses following the resolution.
"To date, there has been only one US downgrade – by S&P in the wake of the 2011 debt ceiling episode. The downgrade did not prevent the USD from regaining ground in the months following the resolution," says Marinov.
Furthermore, he expresses the view that while a failure to resolve the debt ceiling issue, leading to a US default, remains a very unlikely outcome, it could potentially fuel extreme market volatility.
Such a situation could boost the USD and US Treasury securities, given their unparalleled liquidity.
"Last but not least, a potential failure to resolve the debt ceiling issue and a US default remains a very unlikely outcome in our view that could nevertheless fuel extreme market volatility and thus support the USD and USTs given their unparalleled liquidity," he adds.
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