Evening Brief – 06.01.23

Financial markets and monetary policy have yet to feel the ramifications of the US debt ceiling deal. Market participants should contemplate the risks that may follow, which are likely to materialize in three stages.

In tonight’s Evening Brief we present the stage one – Relief.

Financial markets are breathing a sigh of relief now that the near-term danger of the US government missing payments or perhaps defaulting on its debt, which remains the world’s most important “risk-free” asset, has been eliminated – for now.

As the political wrangling over the debt ceiling serves to remind us, “risk free” can sometimes be misleading. But once the deal is finalized, US Treasuries will again be regarded as having the same low risk as they have in the past, at least in terms of the danger of default (the risk of inflation is another issue).

At the very least, a modicum of control was placed on the expansion of government spending thanks to political compromise. The fiscal future for the US cannot be defined as being in a healthy state, but the deal to raise the spending limit has made it a touch better, not worse.

This relief should be favorable for the US dollar and US Treasuries, particularly at the short end of the yield curve, provided that all other factors remain unchanged. On default fears, one-month T-bill yields reached a high of 6.02%. They should now begin to normalize, approaching the Fed’s policy rate of 5%-5.25%.

We will present stage two in Friday’s Evening Brief.