On Wednesday, the value of the US dollar increased and reached a six-week high capitalising on its safe-haven status amidst concerns about a potential US debt default. Additionally, traders reduced their expectations for immediate interest rate cuts by the Federal Reserve after observing robust consumer spending figures in the United States.
US debt ceiling talks
Tense talks over the US debt ceiling between US President Joe Biden and his Republican counterparts continued. While the US President and senior congressman Republican Kevin McCarthy came close to an agreement to increase the US debt ceiling, a final resolution has not been reached at this point. Biden emphasised that a default would lead the economy into a recession, which has raised concerns among investors about the potential negative impact globally.
What is the debt ceiling?
The debt ceiling represents the maximum amount of money that the US government is authorised to borrow in order to fund various services, including social security, Medicare, and military expenditures.
Annually, the government generates revenue through taxes and other sources, but its expenses consistently surpass its income, resulting in a deficit. The accumulated deficit at the end of each year contributes to the country’s overall debt.
To secure funds, the US Treasury issues securities, such as government bonds, which will be repaid with interest. When the government reaches its debt limit, the Treasury becomes unable to issue additional securities, thereby halting a significant source of funding for federal activities.
The responsibility of determining the debt limit falls on Congress, currently set at $31.4 trillion. Since 1960, the debt ceiling has been raised on 78 occasions, under the administrations of both Democratic and Republican presidents.
What will happen if the US defaults?
While it has never happened before, if the US defaults on its payments, the economy will weaken as investors will stay away from the US dollar. There will be job cuts, mortgage rates will rise, impacting the housing market, and the US federal government will be unable to continue all its services.
US treasury secretary Janet Yellen stressed the need for a solution, as the US government faces the risk of defaulting on its bills with catastrophic consequences: global stock markets would crash while the US economy could fall into a recession. In a letter to Congress earlier this year Janet Yellen stressed that “Failure to meet the government’s obligation would cause irreparable harm to the US economy, the livelihoods of all Americans and global financial stability.”
Will the Fed proceed with rate cuts?
The solid growth in consumer spending during April, coupled with statements from Federal Reserve officials, lowered expectations of imminent interest rate cuts in the United States. Given persistent inflation, Fed officials highlighted that it was too early to proceed with rate cuts.
With markets taking out pricing for rate cuts, the dollar is expected to rise further, with a rate hike being possible later this year.
However, according to JPMorgan Asset Management a US recession is almost certain and the Federal Reserve could lower interest rates by the third quarter as economic growth slows down. With inflation being high, they believe that cuts should be expected as recession is the only thing that could push elevated inflation lower.
USD to weaken UBS warns
The safe-haven dollar has got a boost from the debt ceiling impasse, but economists at UBS expect the greenback to weaken against key counterparts over the next 6-12 months. They anticipate Congress to come to an agreement with safe-haven inflows to reverse. They also noted that rate hikes are coming to an end in the US, whereas there will be more to come in Europe.
With the current volatility, contacting a currency specialist will allow you to safeguard your business and finances by planning ahead. If you are a business transferring funds overseas, get in touch with Universal Partners FX and their dedicated team to discuss the latest market movements ahead of your currency exchange. Universal Partners FX can provide invaluable help on efficient risk management and tailored solutions to your business’ transfer needs.