US Dollar (DXY): Facing Uncertainty as Debt Ceiling Agreement Lingers

Highlights

• US dollar declines despite near two-month high.
• Debt ceiling agreement boosts risk sentiment but faces Congressional challenges.
• Expectations of Federal Reserve rate hikes support the US dollar.

Overview

The US dollar, a key global currency, is experiencing a slight decline against major counterparts on Tuesday, despite remaining near a two-month high. The decline comes after a deal was reached on the US debt ceiling, which has boosted risk sentiment. However, the agreement may face challenges in Congress, adding an element of uncertainty to the situation.

The dollar index, which measures the US currency against six major peers, has slipped by 0.125% to 104.17, moving slightly away from the recent high of 104.42 reached on Friday. Nevertheless, the index is expected to register a 2.5% gain for the month, reflecting the overall strength of the US dollar.

Currency Update: Euro, Pound, Yen Rise

In other currency news, the Euro is up 0.09% to $1.0715, while the British Pound is trading at $1.2365, indicating a 0.11% increase for the day. Meanwhile, the Japanese Yen has rebounded by 0.28% to 140.06 per dollar, recovering from a six-month low recorded the previous day.

The Yen’s performance going forward may be influenced by optimism regarding the US avoiding default. If the Dollar/Yen exchange rate sees a significant increase, it could trigger actions by Japanese authorities. This could potentially lead to a strengthening of the Yen in the coming weeks. Factors such as higher US Treasury yields and limited expectations of tightening by the Bank of Japan may contribute to an increase in the USD/JPY exchange rate.

Debt Ceiling Agreement Faces Opposition

Despite the recent debt ceiling agreement, conservative Republican lawmakers have voiced their opposition to the proposed deal. This is adding to the challenges faced by President Joe Biden and House leader Kevin McCarthy. The package needs approval from the Republican-controlled House of Representatives and the Democratic-controlled Senate before the debt limit is reached, which is anticipated to occur by next Monday.

The situation resembles a game of chicken between the two political parties, with neither side willing to back down. However, a middle ground compromise may be reached by raising the debt ceiling and implementing spending reductions in the fiscal year 2024 budget.

The proposed bill, spanning 99 pages, aims to suspend the debt limit until January 1, 2025, effectively postponing the politically sensitive issue until after the presidential election in November 2024. It also includes a cap on certain government expenditures over the next two years. Failure to raise the debt ceiling by June 5 could result in a government default, as warned by US Treasury Secretary Janet Yellen.

Default Uncertainty Lingers, Rate Hike Expectations Support Dollar

The uncertainty surrounding a potential US government default is expected to persist until Congress successfully passes the agreement into law. However, outside of any volatility generated by the debt ceiling issues, expectations for Fed rate hikes are likely to support the US dollar in the near term. Markets are currently pricing in a 60% chance of a 25 basis-point hike in June, compared to a 26% chance just a week earlier.

Furthermore, the debt ceiling deal has had an impact on longer-dated US Treasuries, causing yields to fall as bond prices rise. Benchmark 10-year yields dropped 6 basis points to 3.7596%, while 30-year yields fell 5.5 basis points to 3.9207%.

Resilient Dollar Faces Uncertainty, Rate Hike Support

In conclusion, the US dollar index is showing resilience despite a small decline against major currencies. While the debt ceiling agreement has increased risk sentiment, its passage through Congress remains uncertain.

In the near term, the US dollar is likely to be supported by expectations for Federal Reserve rate hikes. However, the potential for a US government default adds an element of unpredictability to the currency markets.

Technical Analysis

The main trend is up. The index is currently trading within striking distance of 104.406 (R1).  Taking out this level with conviction will indicate the buying is getting stronger. This could trigger an acceleration to the upside with 104.720 (R2) the first target, followed by 105.490 (R3).

A sustained move under 103.631 (S1) will signal the return of sellers. If this creates enough downside momentum then we could see a retest of 102.405 (S2).  That’s the longer-term support.

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