Markets nervous on debt ceiling uncertainty, US yields rise

Markets were cautious on Tuesday as talks over the US debt ceiling offered something for optimists and pessimists, leaving European shares just shy of last week's 15-month top, and US benchmark yields at their highest in two months.

President Joe Biden and House Speaker Kevin McCarthy could not reach an agreement on Monday on how to raise the US government's $31.4 trillion debt ceiling with just 10 days before a possible default.

However, both sides stressed the need to avoid default with a bipartisan deal and said they would continue to talk, leaving investors cautious about making large bets either way, reported Reuters.

Europe's broad STOXX 600 benchmark (.STOXX) slipped 0.25%, trading a little below Friday's 15-month intraday high, largely looking through activity data that showed euro zone business growth remained resilient, if a touch softer than expected.

In company news, Julius Baer's (BAER.S) shares dropped 7.8% after the Swiss wealth manager reported modest money inflows in the first four months, disappointing investors who had expected it to benefit from Credit Suisse's troubles.

But the overall focus remained on events in Washington.

"The best solution is to have a negotiated settlement that raises the debt limit," said Samy Chaar, chief economist at Lombard Odier. Still, he added some investors were considering the market implications of "a compendium of less dramatic solutions, which may or may not be entirely legal, that might be used to avoid an actual default."

These could include using the 14th Amendment to the U.S. constitution, which states that the public debt of the US 'shall not be questioned' though "That would trigger an inevitable lawsuit, which would go to the Supreme Court to resolve the issue once and for all," Chaar said.

In terms of the actual negotiations, "The resumption of debt ceiling negotiations spurred some hopes, despite distinct risks of brinkmanship and blame-shifting remaining on the cards," said Mizuho economist Vishnu Varathan.

However, "Without real action on that front, hawkish Fed speak has (had) some sway on markets," he said, adding that some pressure on US Treasuries has also lent support to the dollar.

Minneapolis Federal Reserve President Neel Kashkari said on Monday that it was a "close call" as to whether he would vote to hike again or pause at next month's meeting.

The comments caused traders to push back expectations for U.S. rate cuts from July towards November or December, sending ten-year and two-year U.S. yields to highs not seen since March.