Mounting hope of a US debt ceiling deal has improved the market mood overnight, propping up equities, commodities, and most currencies relative to the US dollar, with the notable exception of the Lira. If the talked-about 2-year deal is done, we can talk about something else until after the next Presidential election. The result will be relief, and some fiscal tightening.

 

All things being equal this would be slightly dollar negative, but I wonder how much the debt ceiling has really been a driver of FX, given the correlation of currencies with very short-term interest rates of late. The first chart shows December 2023 policy rate pricing for the US, UK Eurozone, Australia and Canada. Australia is the other country where end-2023 rate-pricing is lower today than it was at the end of 2022. The AUD has fallen against the rest of this group, too.

 

The UK leads the way in terms of rate-pricing, and is the strongest of these currencies, and there’s little to choose between the extent of rate re-pricing in the US, Eurozone and Canada, whose currencies are also close to where they started 2023 against each other.

 

I suppose this raises two questions. Firstly, who is going to see their rates repriced from here? And secondly, when will this crazy over-sensitivity to short-term rates be replaced by something else? The UK may hold the answer to both questions. Jeremy Hunt, the UKL’s Chancellor told Sky News that “It’s not a trade-off between tackling inflation and recession, in the end the only path to sustainable growth is to bring down inflation” as he expressed support for tighter monetary policy even if the economy suffers.

 

If the UK does raise rates by another 1%, as is priced by markets, and all that talk of long and variable lags between monetary policy implementation and when it takes effect on the economy are ignored, yet again, recession seems certain. How high will sterling climb from here before it starts falling? Given how much is priced into the curve, this is surely the last leg of the sterling rally.

 

With the focus on policy rates, and US yields rising remorselessly, USD/JPY is up as much as EUR/USD is down this month, but with core inflation at 3.9% in Tokyo, the case for a further YCC adjustment in June, seems strong. EUR/JPY still looks vulnerable.