In recent weeks, the foreign exchange market has turned its attention to the sustainability of the debt of G10 countries. France is once again in the news as another prime minister falls victim to a challenging budgetary situation. However, this is not an issue that only affects France. In the United Kingdom, a new budget will be presented at the end of November and the market is already worried about the possible consequences. Last night, markets received news from the US Congressional Budget Office that the US deficit is likely to hit as high as $1.8 trillion this year, said Michael Pfister, FX analyst at Commerzbank.
US economy weakening despite record-high deficit
“But why is this relevant to exchange rates? As we have argued many times before, the foreign exchange market has not paid much attention to public debt in recent years, at least as far as the G10 countries are concerned. However, this has now changed. The chain of effects is not easy to understand. Some readers may remember that, when the preliminary report of the German fiscal package came out at the end of February and the euro appreciated significantly, we reported here on recent spending. Published a chart to compare the growth with. “Countries that spent more money during the pandemic were generally rewarded with stronger growth.”
“The next step – the relationship between strong growth and the currency – is not so straightforward. Two channels of influence emerge: Strong growth gives the central bank the opportunity to pay closer attention to inflation, for example. Essentially, it can adopt a more restrictive monetary policy than weak growth, which benefits the currency. Secondly, strong growth leads to a stronger currency if investment in the country concerned is more profitable. We have seen this for a long time in the US: a significantly higher real. interest rate This ultimately led to strong demand for the US dollar as everyone wanted to benefit from the strong growth.”
“It seems reasonable to assume that markets will only bear so much. Deficits are already very high, yet governments are still unable to manage them. Moreover, spending is no longer necessarily driving growth. In the US, for example, the economy is weakening despite record-high deficits, meaning the Fed cannot ignore it and must implement less restrictive monetary policy. Stability is also very important for the foreign exchange market so that fiscal Disputes within Western governments could be ignored. Policy. This is likely to dominate us in the coming months. The fact that the options market is becoming increasingly nervous about the UK government’s upcoming budget demonstrates this impressively.”
