The EUR/USD pair failed to consolidate within the 7th figure by the end of the past week: at the end of Friday, EUR/USD bulls organized a small but swift counter-attack, which led the price to rise to the level of 1.0804. The corrective pullback was due to a weakening of the US currency, which came under pressure against the backdrop of Federal Reserve Chairman Jerome Powell's cautious rhetoric.
Powell suggested that the May rate hike could be the last in the current monetary tightening cycle. This unexpected plot twist surprised dollar bulls, afterwards the greenback fell across the market. Under other circumstances, this fundamental factor would have had a strong impact on the dollar for a quite long time. But under current conditions, Powell's dovish comments may take a back seat. The focus is on the political confrontation between Republicans and Democrats, as its failure to reach an agreement could lead to a default on the US national debt.
There is no doubt that this topic will be the "number 1 issue" for all dollar pairs. All other fundamental factors will take a back seat - including Powell.
Biden raises the stakes
Exactly one week ago - May 14 - the President of the United States announced that negotiations with Congress on raising the debt limit are "progressing," and more about their progress will be known literally "in the next two days". At the same time, he emphasized that he is optimistic about the prospects of reaching a compromise. In anticipation of the next round of negotiations, assistants to the US president and the Speaker of the lower house of Congress, Kevin McCarthy, began to form a "road map" to curb federal spending in order to resume negotiations on raising the debt limit.
The negotiations did take place - but ended in failure. The parties just "agreed to agree", but no more. Now the situation is up in the air. Another round of negotiations should take place after Biden completes his visit to Japan, where the G7 summit is being held. At the same time, he canceled his planned visit to Australia, which speaks volumes on the seriousness of the situation.
Important point: if the US president was initially optimistic about the negotiation process, today he has changed the tone of his rhetoric. For example, he stated that declaring a default is "personally out of the question" for him, but at the same time, he cannot guarantee that Republicans will not push the country into default by "doing something outrageous" (originally by Reuters agency - "Biden said he still believed he could reach a deal with Republicans, but could not guarantee that Republicans would not force a default by "doing something outrageous").
In this context, Biden called on Congress to work on the issue of raising the debt limit. He also emphasized that he would not agree to a bipartisan debt ceiling deal "exclusively on the terms of the Republicans". The US president expressed readiness to cut spending, but stated that he does not intend to fulfill all the demands of Republican congressmen.
The terrifying word: "default"
Judging by the escalation of the situation, a default no longer seems unthinkable. One can assume that Biden has decided to raise the stakes with his rhetoric before decisive negotiations, shifting the responsibility for possible default consequences onto the Republican party. However, in the context of forex traders' reaction, it doesn't really matter - whether it's a bluff or a real threat. Such statements from the US president are capable of significantly shaking the markets. Considering that the aforementioned comments were made during the weekend, dollar pair traders should prepare for a significant gap (in the case of the EUR/USD pair - a downward gap).
Overall, the upcoming week is packed with events. For example, on Monday, three representatives of the Federal Reserve (Bullard, Barkin, Bostic) will speak; on Tuesday, PMI indices will be published in Europe, and data on the volume of new home sales will be released in the US; on Wednesday, the minutes of the Fed's May meeting will be published along with a speech by European Central Bank President Christine Lagarde; on Thursday, data on the volume of pending home sales will be disclosed in America; and finally, on Friday, the most important inflation indicator - the core personal consumption expenditures index - will be published in the US.
But all these reports, as well as the speeches of Fed and ECB representatives, will remain in the shadow of the key topic of the upcoming week. The fate of the US national debt is the number 1 issue for dollar pair traders, so everyone will focus on its corresponding negotiations. Especially since there is not much time left until the "X hour": as the US Treasury previously warned, on June 1, the country's government may declare a debt default if Congress cannot raise the debt limit.
Conclusions
Under such fundamental circumstances, it is extremely difficult to predict the possible trajectory of EUR/USD. We can only assume that at the start of the new trading week, risk-off sentiments in the markets will rise again, and this fact will provide significant support to the dollar. In this case, the pair will return to the area of the 7th figure with a target at 1.0700. But everything will depend on the negotiation between Republicans and Democrats. If they do find common ground and announce an increase in the debt limit, the spring will unwind in the opposite direction - against the dollar (especially in light of Powell's recent statements). If the negotiation saga drags on until next weekend, the dollar will continue to gain momentum, acting as a beneficiary of panic sentiments.
Considering the previous statements of Republicans, Democrats, and Biden himself, the negotiations will be very challenging - therefore, dollar pairs may once again find themselves in the area of price turbulence.
