FX.co ★ USD thrives during tough times

The countdown to day X, when the US may default on its debt, is rapidly approaching. However, both Democrats and Republicans remain stagnant, leaving the question of raising the US debt ceiling unresolved. This increases tension in the markets and contributes to the growth of the US dollar.

On Tuesday, the American currency strengthened against its major rivals, reaching 103.65, its highest level since March 20.

Against the euro, the dollar surged to its highest level in a week at 1.0750, and against the pound, it tested a monthly high of 1.2367.

The dollar's climb to new highs was aided by risk-averse sentiment in the markets. Another breakdown in negotiations regarding the debt ceiling limit triggered a wave of panic among investors.

Yesterday's meeting between US President Joe Biden and Republican leaders did not bring any results as no agreement was reached.

Currently, market participants fear that Democrats and Republicans will not be able to reach a deal before the US runs out of cash needed to finance the obligations of the federal government.

In that case, the US will have no choice but to declare a default. Many analysts warn that bankruptcy will significantly weigh on the American economy, which is already on the brink of a recession due to the prolonged monetary tightening cycle.

The risk of an economic slowdown is a negative factor for the US dollar as the Federal Reserve will be unable to continue its aggressive policy and will be forced to shift towards a dovish direction.

However, investors are currently concerned about a much darker prospect. Market participants are afraid that the collapse of the world's largest economy will have repercussions in many countries, leading to a slowdown in global economic growth.

That is why traders flee from risk assets in search of safe havens, with the US dollar being one of the best options for portfolio hedging.

Since the beginning of May, DXY has risen by nearly 2% against a basket of major currencies. Experts believe that the majority of the greenback's gains have come thanks to its protective qualities, and many of them see further potential for USD strengthening amid growing market concerns.

Goldman Sachs predicts that in the near future, the dollar will continue to rise as the risks to the global economy increase with each passing day. Business activity in Europe and China has not lived up to optimistic expectations, while the US is on the verge of bankruptcy and heading into a recession.

Economists at Credit Agricole also expect concerns about global economic stagnation to provide substantial support to the dollar this year.

"Uncertain economic prospects in the US, combined with a sluggish recovery in China, force us to prepare for a downturn. During such periods, pro-cyclical currencies (such as commodities) usually decline, while safe-haven currencies, including the US dollar, show upward momentum," experts stated.

At the same time, Credit Agricole believes that the greenback will still win in the event of a positive outcome of negotiations on raising the debt ceiling.

Of course, the conclusion of the deal will ease fears about a slowdown in economic growth, which will revive risk sentiment in the markets and put pressure on USD.

But on the other hand, bailing out the US from bankruptcy and recession could free the Fed's hands, making investors more hawkish. This is a very favorable scenario for the dollar.

While traders' attention has been focused on the situation with US government debt recently, the monetary policy of the Federal Reserve continues to be one of the key determinants for the American currency.

The strengthening of the greenback this week has been driven not only by increased demand for safe-haven assets but also by the aggressive rhetoric of Federal Reserve members.

Recent comments by James Bullard and Neel Kashkari have prompted investors to reconsider their forecasts regarding the future of the monetary tightening in the US.

Futures traders currently assess the probability of another 25-basis-point interest rate hike in June at nearly 30%, although just a couple of days ago, it was less than 10%.

The rise in hawkish expectations has also been supported by optimistic economic data published on Tuesday.

In April, single-family home sales in the United States surged to a 13-month high, while the composite index of business activity in the manufacturing sector rose to the highest level in a year at 54.5 in May.

Today, investors are expecting to gain further clarity on the future policy of the Federal Reserve. Market participants hope to find hints in the May meeting minutes of the American regulator.

It is worth recalling that last week, Fed Chair Jerome Powell expressed uncertainty about the need to continue the aggressive policy, citing recent disruptions in the country's banking sector and other side effects of tight monetary conditions.

Nevertheless, the recent rhetoric of his colleagues has shown that the majority of the members of the American central bank are still interested in further rate hikes. Therefore, there is every reason to believe that the overall tone of the FOMC minutes may turn out to be hawkish.

If the market receives a hint today of another round of tightening in the United States, the dollar's exchange rate will soar across the board. Conversely, dovish signals from the Fed minutes could lead to a decline in USD, although its decline is likely to be significantly limited due to risk aversion.