FX.co ★ EUR/USD: Threat of default has not disappeared

EUR/USD remains under pressure despite optimistic news that U.S. President Joe Biden and House Speaker Kevin McCarthy have reached an "agreement in principle" on raising the debt ceiling. Nevertheless, the greenback continues to hold its ground. The U.S. Dollar Index today rose to 104.43, reaching this level for the first time since mid-March. In turn, the EUR/USD pair hit a two-month low, testing the 1.06 figure area for the first time since March. Such price dynamics are primarily driven by increased risk aversion in the markets. After all, the threat of default has not disappeared; the parties have signed an intention declaration that does not guarantee a final outcome. This fact provides situational support to the safe-haven dollar.

To briefly recap, the reached preliminary agreement will raise the debt ceiling for 2024 and 2025 while limiting non-defense spending at the current fiscal year level. The agreements include freezing spending on domestic programs, increasing defense and veteran spending, introducing new requirements for federal food assistance programs, and changing some rules for obtaining energy extraction permits.

It is worth noting that market participants initially reacted skeptically to this news. Compromise is always a concession that congressmen of both parties must make. In fact, Biden himself, commenting on the negotiation results, stated that the agreement "contains provisions that should sway members of both parties to vote for the document." On the other hand, Biden emphasized that the agreement "represents a compromise, which means not everyone gets what they want."

Immediately after the decision, some representatives from both Democrats and Republicans voiced opposition to certain details of the deal. Certain congressmen have directly threatened to withdraw support for the compromise legislation (including so-called far-right Republicans).

Concerns about the viability of the U.S. debt ceiling pact have dampened risk sentiment in the markets, allowing the safe-haven dollar to regain momentum.

The intrigue will be resolved in the coming days. As representatives of the House Rules Committee announced, they will consider the agreement on Tuesday during the U.S. trading session. A positive decision by the committee can pave the way for a vote in the Republican-controlled House of Representatives. The document will then go to the Senate, controlled by the Democrats, before reaching Biden's desk for signature.

It is noteworthy that the White House chief continues to express optimism about the prospects of the bill's passage. Today, he stated that he has no doubt that the document will be approved by Congress by June 5. However, judging by the reaction of the currency market, traders are not so confident in a happy ending in the near term.

All of this suggests that the situation for the EUR/USD pair remains fragile. If the aforementioned risks do not materialize and Congress "unanimously" supports the compromise legislation (expected around May 31st or early June), interest in risk may rise again. The dollar will come under pressure, and "classic" fundamental factors will return to the forefront. Especially considering that important releases for EUR/USD will be published at the end of the week, which may support buyers of the pair.

On Thursday, we will learn key data on inflation growth in the Eurozone. According to preliminary forecasts, the overall consumer price index in May will sharply decrease from 7.0% to 6.3%. However, the core index may resume its upward trend, rising to 5.7% (according to other estimates, up to 5.8%). If the release remains in the green zone, the euro will strengthen its position across the market.

Another important event of the week for traders will be the Nonfarm Payrolls, which will be published on Friday. According to forecasts, the unemployment rate in May is expected to increase slightly to 3.5%. The number of employed in the non-farm sector is expected to grow by only 160,000. The inflation component of Nonfarm Payrolls (average hourly earnings) may also demonstrate a downward trend. In monthly terms, the indicator is expected to grow by 0.4% (compared to April's value of 0.5%), and in annual terms, by 4.2% (compared to April's value of 4.4%).

Once again, it is important to emphasize a crucial point: the aforementioned releases (Eurozone inflation and Nonfarm Payrolls) will only be in the spotlight for EUR/USD traders if the saga of raising the U.S. debt ceiling is behind us. In other words, if both houses of Congress approve the compromise legislation by the end of the week. Until then, the political battles in Washington will be the number one topic for traders.

The intrigue will be resolved in the coming days, so making trading decisions for the EUR/USD pair is still risky. Political events can fundamentally "redraw" the fundamental backdrop for all dollar pairs, and the EUR/USD pair will not be an exception here.