US debt limit accord reached, still to be voted on

OVERNIGHT

Risk tone was cautious during the Asian trading session despite positive developments in US debt ceiling negotiations. A deal was reached between President Biden and House Speaker McCarthy to reduce spending in return for a suspension of the debt ceiling until after the next Presidential election. The accord is expected to be voted on by Congress from Wednesday and will avoid a US debt default. Cautious investor optimism led to falls in short-term Treasury bills and most Treasury yields.

THE DAY AHEAD

UK interest rate concerns rose sharply last week following CPI data which showed a smaller than expected fall in overall inflation and a rise a core inflation. In response, markets are now pricing in a very high likelihood of the Bank of England policy interest rate reaching 5.5% by the autumn. The concern seems to be that, so far, economic growth and in particular the labour market is holding up better than expected to interest rate hikes and that, as a result, a second round of domestic inflationary pressures are gathering pace. Those concerns were further fuelled by the widespread nature of the rise in April core inflation.

This week’s UK data calendar is fairly sparse. Overnight, the BRC shop price index provided a very early gauge of May inflation showing a further rise in the overall index to 9.0% from 8.8%, although food price inflation slowed to 15.4% from 15.7%. There are no major releases ahead today, but early Wednesday sees the release of our Business Barometer report for May for further indications of how well business confidence and economic activity are holding up and on the impact of recent news on inflation and wage expectations. 

The global focus is also very much on inflation. This morning’s Spanish CPI data and tomorrow’s French, German and Italian figures will provide an early hint for the Eurozone flash estimate which will be released on Thursday. We are looking for a combination of another sharp drop in headline inflation but stickiness in the core rate. That seems unlikely to lead to any revision to market expectations that Eurozone interest rates will be raised by another 25bp in June even though Germany’s economy is now known to have fallen into recession over the winter.

Meanwhile in China, May PMI overnight (early Wednesday) will provide a further signal of the strength of economic growth amid signs that the initial rebound following the lifting of restrictions is petering out. 

MARKETS

US, UK and some other markets return after yesterday’s public holiday. The pound rose briefly overnight but the gains dissipated, leaving it little changed below $1.2350 and above €1.15. US 10-year Treasury yields fell by 4bp to 3.76% following news of an agreement on the debt ceiling issue. Two-year yields, however, were little changed with markets pricing in slightly better-than-evens probability of another Fed hike next month.