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Run away moves in US equity ahead of a debt ceiling vote

Direttore della ricerca

19 mag 2023

Like a phoenix from the flames, we’re seeing life emerge from a low volatility market – the NAS100 is in beast mode, we see the US500 breaking out above the 4160 range highs, and the USD is starting to bull trend.

(NAS100 daily chart)

Preview

Out of the blue anticipation is building for a big weekend and week ahead in US politics, where the outcome could have far-reaching implications for the NAS100, US500 and USD, and by extension second order derivatives, such as gold.

In my view, 4 key focus points will be debated:

A time to chase risk higher? Do we see a bill passed where the market continues to express relief and add length to recent positioning?
Are the markets set up for potential failure? What happens if the initial plan – when it comes - is voted down in the House next week?
After a strong rally could these markets be eyeing a buy the rumour, sell the fact scenario playing out?
Despite many economists calling for a pause, could we be looking at a ‘live’ May FOMC meeting and a coin toss as to whether the Fed hike by 25bp or pause?

The bulls are certainly in control of big tech and the USD and sensing the US debt ceiling saga could be put to bed soon enough. This would avoid heading past 1 June and into a period where the US Treasury run a dangerously low cash balance, increasing the risk an essential payment may be missed or deferred.

Both high-ranking Republicans and Democrats, and their key staff, are coming together and offering constructive views that a deal is within reach - far sooner than most public policy experts had anticipated.

Traders are now on edge for headlines of an agreement in principle between Democrat and Republican leaders that can be put to the House for a vote early next week. It makes this weekend’s news flow well worth following and offers modest asymmetric gapping risk for the Monday open.

The devil is in the detail

When it comes to a bill being put to the House, the devil will be in the detail and the more contentious measures such as spending cuts need to appeal to both conservatives and moderates in the House. In theory, once it passes the House then the Senate (who are on recess this coming week) would have a vote.

The markets suspect that if the deal has been agreed and brokered by Dem & Rep leaders it should get enough bipartisan support to pass – and if not on the first attempt, then it would be reworked quick enough to be voted on again before early June.

The big kicker for the USD

For USD traders there are other considerations and not just debt ceiling hedges being unwound. On one hand, the US data has started to come in better than feared raising the probability of a June Fed hike. On the other, we’re also looking at the prospect of the US Treasury issuing c$1t of US T-bills once the debt ceiling extension has been fully signed off.

Essentially the effect of issuing so much short-term debt would be a massive rebuild of the Treasury General Account (TGA – the US Treasury’s checking account held with the Fed). Essentially, we could see this as a massive liquidity drain of capital out of the private sector, in turn, sucking USDs from the system, a potential significant USD tailwind.

What happens if the deal is voted down?

While it seems a reduced possibility, the risk manager in me feels it prudent to look at the scenario where a deal fails to pass the House – naturally, we would need to know the extent by which the vote failed and the exact fiscal measures which caused it to fail. If it failed by a large margin, it would raise concerns that it might not be worked by early June. Here, the bullish price action and flow in the NAS100, US500 and USD would reverse hard and pricing risk would become more problematic – buying volatility would work well here.

It is all to play for

Could we be looking at further bullish price action, higher highs and FOMO kicking into the equity move as active managers case the tape higher? Conversely, is the market fully priced for a favourable outcome, and where there may be an unexpected turn in the script?

Twitter will be alive with headlines this week and well worth following. It's refreshing to see some life in these core markets though, and as always keeping an open mind and reacting to price action will serve you well.

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