After reaching a two-month high, the U.S. dollar stabilized while European stocks leveled off on Tuesday. The initial relief that a potential U.S. government default had been averted was replaced by apprehension regarding the deal’s uncertain journey through Congress.
Positive Response from Traders
Traders responded positively as the U.S. dollar index and long-term U.S. Treasuries surged following the announcement of a deal to suspend Washington’s borrowing limit until January 2025. This agreement came with spending caps and government program cuts. However, European stocks faltered earlier in the day due to uncertainty surrounding the bill’s approval in Congress. Several right-wing Republican lawmakers declared their opposition to the bill on Monday, although it is still expected to pass.
Potentially Negative Consequences
While there was initially a risk-on sentiment due to the deal announced over the weekend, investors now harbor concerns that the agreement represents a compromise with potentially negative consequences. James Rosenberg, an advisor at broker Ord Minnett in Sydney, commented on the outcome, stating that the U.S. resolution to the debt ceiling negotiations was inadequate, with a significant increase in government debt and no substantial spending cuts. Nevertheless, it temporarily relieved the pressure. Rosenberg pointed out the substantial divergence between the bond market and equities, with the bond market pricing in a U.S. recession.
Analysts at JB Were warned of a potential $600 billion in bill issuance over the next six to eight weeks. The market is now grappling with the size of the Treasury issuance and its economic implications, as noted by Invesco’s Asia Pacific global strategist, David Chao. Chao explained that while the near-term announcement of a debt deal boosts market sentiment, it places pressure on growth due to government spending cuts and tighter liquidity conditions. The U.S. dollar index, which measures the U.S. currency against six major peers. On the flip side, this pressure on growth helps the Federal Reserve’s effort to cool the economy and control inflation.
European Stock Flattens
The pan-European STOXX 600 index flattened after experiencing its largest weekly decline in two months on Friday. The Nikkei stock index in Japan, however, rose by 0.3% following Monday’s surge to a 33-year high. Optimism surrounding the U.S. debt deal and a weaker yen, which benefits Japanese exporters, contributed to the positive sentiment. Hong Kong’s Hang Seng Index and China’s CSI300 Index closed nearly flat, having reached their lowest levels since November. Investors remain cautious ahead of China’s May manufacturing data, scheduled for release on Wednesday.
What is the debt ceiling?
U.S. futures indicated a positive start for U.S. stocks with a 0.5% increase. This comes after the Memorial Day holiday on Monday when the U.S. markets were closed. U.S. 10-year bond yields dropped by 8 basis points to 3.74%, while thirty-year yields fell 6 bps to 3.91%.
The dollar index, measuring the performance of the greenback against six major currencies, stabilized at 104.3 after reaching a two-month high. Additionally, it traded near a six-month peak against the Chinese yuan.