Nasdaq 100 heads to 12 month high as debt ceiling deal looks close

Nasdaq 100 led equity markets higher even as bond markets dipped. Markets reacted positively to the belief that a deal on the debt ceiling is close (surprise surprise), but better than expected economic data led to the expectation that official rates will go higher (something not expected a few months ago.) The US dollar held on to recent gains, gold was unchanged, and oil bounced back after recent profit taking.

TODAY’S MAJOR NEWS

Debt deal likely, serious reform kicked down the road

The Treasury Department warns that it could run out of cash on or shortly after June 1, next Thursday, but a solution seems in reach. With markets closed for the Memorial Day holiday on Monday, we are down to the wire. A deal is not yet inked, and while there is a sense of optimism, a path to a deal is becoming clear.

Media reports indicate that the White House and House Republicans may agree raising the debt ceiling for two years, putting off the next showdown until after the 2024 presidential election, if the following points can be agreed: capping non-defense discretionary spending at current-year levels; scaling back White House plans to hire thousands of tax auditors; accepting Republicans demands not to increase corporate taxes; and, accepting White House demands not to include work requirements to receive social assistance.

If a deal is agreed between President Biden and Leader McCarthy, each then has to convince enough members of their separate parties to vote for the agreement, no mean feat with both parties holding very narrow margins over their respective houses. Regardless, the risk of a Fitch credit downgrade still remains on the table, until a deal is done.

The current debt limit sits at $31.4 trillion, although actual obligations are currently near $31.8 trillion and rising. The national debt prior to the pandemic was $23.2 trillion. This year's anticipated interest cost for that debt is $573 billion, and rapidly rising as maturing debt certificates are rolled at today's higher rates. That interest cost obligation is projected to be $1.7 trillion just four years from now if we do nothing to change our current trajectory. That would have significant implications for both the US economy and financial markets. We might just be kicking a very big can down the road.

Strong consumer spending, durable goods data spark belief in more rate hikes

Consumer spending rose at twice the expected pace in April, driving prices higher and reigniting inflation concerns. Durable goods orders also bounced back last month. May’s decline in the Michigan Consumer Sentiment Index is largely ascribed to worries about the path of interest rates and the economy as the nation headed into a potential debt ceiling crisis. However, today’s data provides another indicator of the underlying economic momentum and the stickiness of inflation. This news pushed Fed fund futures trading this morning to price in 57% odds of another rate hike at the Fed’s June meeting, up from just 17% a week ago. Traders now put 58% odds that the Fed’s benchmark rate will be at 5% or higher at the end of this year, which is up from just 8% odds a week ago.

Bottom line – risk-on

Financial markets swung back to the risk-on camp today on hopes for a debt ceiling deal and in the face of higher interest rate expectations.

TODAY’S MAJOR MARKETS

Equity markets

• The S&P 500, Russell 2000 and Nasdaq 100 rose by 1.1%, 1.0% and 2.1%, respectively this morning
• The DAX and FTSE 100 were up 0.8% and 0.7%, respectively
• The VIX, Wall Street’s fear index, fell 7.1% to 17.8

Currencies and Bonds

• The dollar index was unchanged at 104.2 against a basket of currencies, maintaining recent strength, and Euro/Dollar and Dollar/Sterling were also unchanged
• Yields on 2- and 10-year Treasuries edged higher at 4.56% and 3.81%, with shorter-dated notes hitting an 11-week high reflecting expectations that official rates could rise again

Commodities

• Gold prices were unchanged at $1,943 per ounce
• Crude oil prices rebounded by 0.8% to $72.4 per barrel
• Wheat prices continue to lead the complex lower amid a media focus on wheat imports
• Grain and oilseed markets were mostly higher as well, supported by the belief that a dry growing season across the Midwest will impact future supply

Personal Consumer Expenditure (PCE) shows stronger income, consumption and prices

• Headline personal consumption expenditures rose 0.8% month-on-month in April, twice the 0.4% expected, and up from 0.1% in March – not indication of consumer spending being curbed
• Within PCE data, personal income saw 0.4% month-on-month gains in April, as expected, and up from 0.3% the previous month – so no sign that wages are under pressure
• Headline PCE price index rose 4.4% year-on-year in April, versus an expected 4.3%, and up from 4.2% the previous month – again, no slowing price inflation
• Core PCE price index, excluding more volatile food and energy sectors, was up 4.7% year-on-year in April, beating analyst estimates that it would be unchanged at 4.6%

Durable goods orders stronger than expected

• Durable goods orders rose 1.1% month-on-month in April, when a decline was expected, and following a 3.3% gain in March
• Durable goods orders minus transportation fell 0.2% month-on-month in April, when a 0.1% decline was expected, and after a 0.3% gains the previous month
• Core durable goods orders, an indicator of business sentiment, rose 1.4% month-on-month, after a 0.6% decline the previous month

University of Michigan (UoM) Consumer Sentiment Index dips in May versus April

• The UoM consumer sentiment index came in at 59.2 in May, up from the preliminary 57.7, and ahead of an expected 58.0
• For context, the index was 63.5 in April, but just 58.4 a year ago
• The current conditions index fell to 64.9, down from 68.2 in April, but up from 63.3 a year ago
• Consumer expectations fell to 55.4, down from 60.5 in April, but slightly above the 55.2 posted a year ago
• Year-ahead inflation expectations slipped to 4.2%, down from 4.6% in April
• Long-term inflation expectations remain within the narrow 2.9 – 3.1% range seen for the past two years

China’s economic numbers continue to slide with little hope of government stimulus

• The ability of China’s government to provide a stimulus to a slowing economy is limited, while the US and other major economies are tightening could devalue the yuan
• China’s auto production and sales fell 17.5% and 11.9%, respectively, month-on-month in April
• New home sales were down 13% month-on-month in April
• Many government units within China are rumored to have debt problems of their own, limiting their ability to stimulate the economy
• Rating agencies have downgraded credit ratings on a number of Chinese local governments, suggesting a declining demand for construction and metals amid lower investments in government led infrastructure projects

Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com

Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com