Deutsche Bank says a combination of recent political signals and easing energy risks should help reduce policy-related premiums in markets and provide backing for the euro against the dollar.
In its assessment, the bank highlights two political features that work to lower the odds of extreme policy outcomes: a Democratic majority in Congress and President Trump’s apparent willingness to cooperate with the opposition. Over the past 48 hours, the bank notes, President Trump indicated that an attack on Iran is not imminent and acknowledged that the Iran war influenced part of the recent election results.
Those comments come against a backdrop of materially recovered oil flows through the Middle East, according to Deutsche Bank. The bank observes that markets had been pricing a large, immediate risk premium tied to re-escalation and potential energy supply disruptions - a premium that should ease as flows normalize.
Despite the easing in global policy and energy risk premia, Deutsche Bank identifies the U.S. debt ceiling as the single largest remaining source of domestic policy uncertainty. The bank states the limit is expected to become binding by the second quarter of next year. Against that timeline, it reports that Republicans are aiming to pass a debt ceiling increase via reconciliation over the coming weeks.
Deutsche Bank argues that a successful increase in the debt ceiling would remove an additional layer of uncertainty around fiscal policy. Achieving that outcome would also, the bank says, reduce the risk that discussions over fiscal policy become a vehicle to bundle in other issues - such as AI policy and other agenda items - into protracted negotiations with a Democratic Congress. The bank also stresses that uncertainty around the build-out and implementation of AI technologies is likely to persist regardless of debt ceiling outcomes.
Weighing these factors, Deutsche Bank sees recent political developments as supportive of a continued bottoming process in EUR/USD. The bank reasons that, on balance, lower energy and global policy risk premia combined with elevated risks related to AI implementation should weaken the dollar. It adds that a failure to secure a debt ceiling increase this year would represent an additional dollar-negative outcome.
Implications noted by the bank include potential relief in FX volatility as headline geopolitical and energy worries recede, while fiscal negotiations and AI implementation remain sources of uncertainty for markets.