The US debt ceiling negotiations continue to hold markets captive, as the clock continues to tick. Ahead of today’s negotiations, officials have been cautiously speaking out of both sides of their mouth, stating they are still far away but reiterating that a default is not an option and that a deal can still be reached. While last-minute agreement is still the consensus, market volatility is expected to linger, and some strategists have already begun contemplating the negative liquidity implications.
As the final countdown begins, José Torres, Senior Economist at Interactive Brokers, provides the most recent updates on the US debt ceiling problem and the current situation in the financial markets.
Equities are down for the third consecutive day as investors grow increasingly worried about continued brinkmanship in Washington over raising the debt ceiling. With seven short days until the June 1 deadline recognized by Secretary of the Treasury Janet Yellen as the point at which the US would default on debt, meaningful progress on reaching a deal has been hard to come by for negotiations.
While leaders from both parties have at times attempted to strike a positive tone by calling talks productive and effective, an actual agreement that will spare investors from further pain is nowhere to be found.
Rather than increasing spending in the next budget, President Joe Biden has proposed a spending freeze and limits on future fiscal-year spending increases, while Republican House Speaker Kevin McCarthy has emphasized that spending in the coming years must be reduced significantly.
In the meantime, Republican plans to cut spending will likely lead to a sharper downturn in the second half of this year as the economy transitions from a period of robust fiscal spending towards austerity. Republicans, for their part, believe spending must be reduced to address the country’s growing debt, which they believe is unsustainable at $31.4 trillion.
McCarthy continues to reference the budget health of a typical household when speaking to negotiators and the public, emphasizing that the nation needs to move towards a balanced budget, where revenues and expenses shift into improved alignment.
Equities are down as a failure to strike a deal will lead to an immediate recession. Investor pessimism is propping up volatility as traders pile on wagers to protect against potential downside with the Volatility Index (VIX) up 10.7% to 20.51.
Bond yields are modestly higher across the board, led by debt-ceiling fears and expectations of a tighter Fed. Investors are placing the odds of a 25-basis point (bp) hike at next month’s meeting at 32%. The 2-year Treasury yield is up 3 bps to 4.31% while the 10-year is up 1 bp to 3.71%.
A disciplined Fed persists in supporting the dollar, as the greenback continues to gain momentum from its April low of 100.8. The Dollar Index is up 30 bps to 103.78, a meaningful gain in the last few weeks. Crude oil is up strongly again, a day after Saudi Arabian Oil Minister Prince Abdulaziz bin Salman told oil shorts to “watch out,” reflecting a bullish outlook from the kingdom’s oil ministry. WTI crude oil is up 2.1% to $74.42 per barrel.