Market Deep Dive: Low trading volumes and potential US debt ceiling stand-off

This week was quiet, with low trading volumes in the crypto markets alongside historically low realised and implied volatilities.

In terms of price, cryptocurrencies performed slightly negatively this week. BTC$ is trading 1.7% lower at $26,430, and ETH$ remains nearly unchanged, currently trading slightly above $1,800.

On the news front, we saw no major surprises this week. In the UK, inflation data came in higher than expected, reminding us that there is still a long and potentially challenging road ahead to normalise inflation levels. The FOMC Minutes on Wednesday revealed no significant news, and the rates market showed little reaction. The market is still pricing in a roughly 50% chance of another 25 bps hike in either June or July (with a good likelihood of the first rate cut occurring by the end of this year). This means that expectations have not changed much in the past two weeks.

Yesterday’s GDP in the US printed higher than expected, while initial jobless claims were slightly lower than expected.

Although a cooling down of the US economy is widely expected, the economy remains strong.

Looking ahead, the biggest potential volatility driver for the coming week is certainly the debt ceiling stand-off between the Republican and Democratic parties in the US. Is the fear of a potential US default justified?

The debt ceiling is a specific US issue where Congress decides how much debt the government can issue. It has been in existence since 1917 (before that, Congress had to decide on every single credit), and it has been raised 78 times since 1960 alone.

The current limit of USD 31.4 trillion was already reached by January 19th of this year, preventing the Biden administration from issuing new debt. Until now, the government has been able to service its obligations by depleting reserves, but Finance Minister Janet Yellen is warning that the government will run out of money by June 1st. It is not clear if the US would default in early June, as the government could take some extraordinary measures to prevent a default on US debt for a short period.

As of now, there is still no agreement in sight, and finding common ground seems challenging. Joe Biden and House of Representatives Speaker McCarthy are at odds over spending, taxes, subsidies for green energy, and social welfare programmes.

The last time the US was this close to a default was back in 2011, and an agreement to raise the debt ceiling was only reached at the last minute. As a consequence, S&P downgraded the US government’s credit rating below AAA for the first time. The market also took a big hit, with the S&P dropping 17% in July and August of 2011.

Neither the Republican nor the Democratic party has an interest in the devastating impacts an actual default of US government debt would have. It is, therefore, very likely that an agreement in this “Chicken Game” will be reached at the last minute. However, no matter how small the odds of a US default might be, even a slight shift in the likelihood of this tail event with unforeseeable consequences will make market participants nervous and create volatility.

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