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Markets to tread water as debt ceiling talks set to restart

Markets in Europe and Asia made strong gains last week, with the Nikkei 225 rising to its best levels since 1990, and the DAX setting a new record high. The FTSE 100 once again failed to keep up, closing a miserable two points higher on the week. 

US markets also managed to produce some strong gains, with the Nasdaq 100 closing at one-year highs, breaking above its recent range highs, and almost 3.5% higher on the week. The weekly performance could have been stronger, but for a late announcement that debt ceiling talks between Democrats and Republicans had broken down after the Republicans staged a late walk out, citing unreasonable demands from the White House. 

Up until late Friday afternoon markets had been steadily rising on an expectation that this week would see a deal come to a vote, and an expectation that a deal would be agreed. There is a sense that a lot of what is happening in DC is very much optics on the part of both Democrats and Republicans as both seek to throw red meat to their political base, however given the size of the stakes there is a feeling that we are only a heartbeat away from a political miscalculation and a default by mistake. 

An avoidance of a default is still the markets base line view even accounting for Friday’s late drop in US markets, which took some of the gloss of a very positive week for global stock markets. As we look ahead to a new and another important week, and the resumption of debt ceiling talks later today, there is a sense that we are likely to see a few more twists and turns in this sorry saga, with neither side coming out of it particularly well. 

While political uncertainty appears to be being largely put to one side, US interest rate rise expectations have also risen, with the resilience of recent economic data helping to push US bond yields higher, as barring a political mishap we could see the US Federal Reserve look to hike again in June, or at least signal a hawkish hold. 

This week’s Fed minutes could well offer an insight into some signs of the divergence that is starting to manifest itself in some of statements coming from senior Fed officials over the last few days. Many of them have leant to the hawkish side, such as Dallas Fed president Lori Logan, who articulated the view that the data doesn’t support the idea of a pause at the June meeting. We also had less than dovish steers from Fed governors Michelle Bowman and Philip Jefferson expressing a reluctance to offer anything other than a pause at the next meeting. 

Fed chair Jay Powell also spoke last week, and while he tempered his remarks, he also didn’t rule out the possibility of more rate hikes, even as he acknowledged that the recent volatility was likely to mean rates wouldn’t have to rise as much. While the Fed minutes on Wednesday will give an insight into the discussions over the 25bps hike, we may also get an insight as to whether there was a serious debate over a rate hold. The US dollar index also managed to put in a strong week as markets repriced the prospect that US rates were likely to stay higher for longer. 

We finish this week with the latest core PCE inflation numbers for April, which are expected to see inflation edge up slightly to 4.3%, in a sign that prices might have hit a short-term base for the time being.  

EUR/USD – finding support at the 1.0760 area, which has seen a modest pullback, but we need to see a move back through 1.0840 to stabilise. Below 1.0760 opens up a potential move towards 1.0610, with initial support at 1.0710.

GBP/USD – finding support just above 1.2370/80 trend line support from the October lows last year. Resistance currently all the way back at 1.2540. Below 1.2360 opens the potential for a move back towards 1.2270.  

EUR/GBP – finding resistance just below the 0.8740 area and the 200-day SMA, while holding above the May low at 0.8660 key support. A move below 0.8650 could see a move towards 0.8620.

USD/JPY – broken above the 200-day SMA at 137.00 which is now acting as support. While above here the risk is for a move towards 139.60 which is a 50% retracement of the down move from the recent highs at 151.95 and lows at 127.20. A fall below 136.80 targets a return to 135.60.

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