US debt ceiling – Deal in reach
Over the weekend, Republican leadership found an agreement in principle with the Democratic administration to increase the US debt ceiling. Under the deal, Republicans allow for an increase which postpones any new issue to 2025, vis-à-vis a domestic spending freeze and moderate growth in military spending over the next two years. The deal will be voted in the House and the Senate on Wednesday. The agreement will help markets relieve, though a solution was arguably 80% priced by last Friday. Markets will move on to focus on the upcoming Federal Reserve decision. Rates price a 50% chance of a hike, while recent soft inflation data are more supportive of a hold. Labour market data on Friday will offer more clues about the direction of travel. Consensus currently expect softening data, but still expansionary levels.
UK – Strong inflation brings UK bonds to their knees
UK government debt sold off strongly this week, amid another consecutive inflation surprise to the upside: Headline CPI fell to 8.7%, above consensus forecasts of 8.2% and the BoE forecast of 8.4%. 2y yields rose 60bp over the past 5 days, and markets now estimate the BoE terminal rate at 5.6%, 1.1% above the current bank rate. We think the price action has been exacerbated by stop-outs and systematic selling and think UK yields are too high both in absolute terms and relative to global curves.
Turkey – No time for a change
The second round of Presidential elections in Turkey sees a victory of the incumbent President, Mr Erdogan. The outcome was expected after his strong performance in the first round on May 14th. The results will likely lead to a continuation of the macroeconomic policies that characterised the past two years. Monetary policy will remain easy despite high levels of inflation (real rates are currently -40%), and the focus on stimulating the economy will trump financial stability. The country’s central bank has a negative financial position, as hard currency reserves stand below the stock of dollars borrowed by local banks. Ongoing imbalances reached extreme levels and are likely to increase further in absence of policy change.
Algebris Investments’ Global Credit Team
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