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Fed Rate Hike Expectations Ease Amid Debt Ceiling Tensions, Fueling Market Reactions 


U.S. stocks closed lower Friday, 19th May 2023 as debt ceiling talks broke down, with no immediate plans to resume. However, the declines were relatively small as investors remain optimistic that a deal will be reached before the deadline. 

In light of Federal Reserve Chairman Jerome Powell’s indication of a pause, traders have reduced their bets on a June rate hike to 25%. Combined with the uncertainty surrounding the debt ceiling, this adjustment seems more appropriate. 

Regional bank shares were under pressure after Treasury Secretary Janet Yellen suggested said that more mergers might be needed. 

Foot Locker shares experienced a 27% decline after the company reported that lower tax refunds and increased prices for gas, food, and rent were affecting its customers’ spending on discretionary goods. 

For the week, the three major indexes recorded gains, with the Nasdaq Composite leading the way with a 3% increase, its best weekly performance since March. The S&P 500 saw a 1.6% jump, and the Dow Jones Average added 0.4%.  

Here are the closing levels on Friday, 19th May 2023:

 Last Change %Chnage 
Dow Jones 33,426.63. -109.28. -0.33% 
S&P 500 4,191.98 -6.07. -0.14% 
Nasdaq Comp12,657.90 -30.94. -0.24% 
US 10Y 3.67%   
VIX 16.81 +0.76 +4.74% 

Debt ceiling. That was the driver of the markets last week. 

It is worth noting that most of the gains came from a few mega-cap names, which have been major drivers of the market this year. 

Friday’s market close was attributed to the debt ceiling impasse, but considering the modest drop in prices, it appears that investors are confident that a deal will be reached soon. 

According to the CME Fed Watch tool, there is now a 44.7% probability that the Funds rate will be between 4.50% and 4.75%. This is a change from the previous week’s prediction of 4.25% to 4.50%, indicating a revised expectation of 2 Fed cuts by the end of the year instead of 3. 

I mentioned earlier that as long as the market’s perception of rate cuts remains unchanged, investors will likely maintain a bullish outlook. The market’s significant jump was primarily attributed to the debt ceiling situation, and the revised expectations for Fed cuts may not have been fully factored in yet. 

The debt ceiling issue is expected to introduce volatility into the markets until it is resolved. Once it is resolved, market attention will likely shift back to the economy, which may or may not be as bullish, particularly if fewer Fed cuts are anticipated this year. 

Another concern is that some profit-taking might be occurring, given the substantial rallies of a few mega-cap names. 

Source: CBOE, Bloomberg, CME Group 

This commentary is written by James Gomes.
James has been in the finance industry for over 30 years and most recently worked for a large U.S. bank for more than 20 years.

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