US equities impacted by the US debt ceiling uncertainty
The uncertainty over the raising of the US debt ceiling is being felt across major markets. This uncertainty is manifesting in a stagnating drift of negative sentiment. There is no decisive selling pressure, but the USD is starting to gain ground and the rally in US equities is finding resistance.
For now, the mega-cap US tech stocks are still holding up well. However, this seems to be masking the souring sentiment that continues to develop across Wall Street.
- Progress in the debt ceiling talks is slow and uncertain
- US big tech still holding up stocks
- Volatility is likely to ramp up in the coming weeks
Progress in debt ceiling talks remains slow
If the debt ceiling of $31.4 trillion is not lifted soon, the US Government will begin to default on its obligations. Treasury Secretary Janet Yellen has continued to argue that the US Government will only be able to pay its bills up until 1st June. If Yellen is correct and she is not just political scaremongering, that gives the Democrats and the Republicans a little under two weeks to sort the situation out.
Now, I like to think I am of a rational mind, so I continue to expect supposedly intelligent US lawmakers to come to an agreement and avoid plunging the US and by extension, the world financial system into turmoil. However, the possibility is still there that this will not happen. Hence the uncertainty that markets are feeling.
Reportedly, Republican House speaker Kevin McCarthy believes that talks with President Biden are edging closer to a deal and that “it is possible to get a deal by the end of the week”. The Democrats want Biden’s spending plans to go through with higher taxes (on the wealthy mainly), but the Republicans are resistant to the take hikes.
Markets will have to play a waiting game whilst the two sides squabble.
Big tech is still holding up markets
Market reaction is showing signs of caution. The US dollar is picking up, with US Treasury yields also higher. Yields are higher despite the soggy data that is painting a concerning picture of the US consumer in recent days (disappointing Michigan Sentiment, mixed Retail Sales and weak results from Home Depot).
However, moves in US equity markets show an interesting picture. There is a broad nervous feeling developing, but the big tech stocks are doing the heavy lifting as markets consolidate.
The chart above shows that despite the debt ceiling fears, US Big Tech stocks continue to pull higher. This is great news for the broader growth stocks, as shown with the Russell 100 Growth EFT continuing to grind higher (the e-mini NASDAQ 100 futures also continue to pull higher). However, outside the tech and growth stocks, we see the falling over of the value stocks. This is leaving the S&P 500 stuck in the middle going almost nowhere.
It would also suggest though that without the tech stocks (the Technology sector alone accounts for around 27% of the S&P 500 Index), the S&P 500 would already be falling over.
Increased volatility is likely
For now, markets are fairly calm. Bond market volatility is still elevated from the banking crisis, but it is reasonably settled around levels that it has been since the Ukraine war began. Forex volatility continues to fall to 15-month lows, again reflecting a nervous anticipation. The VIX Index of S&P 500 options volatility has picked up slightly in recent days, to around 18, but again given the levels of uncertainty, this is still very contained.
However, if the debt ceiling is not resolved in the next couple of weeks, we can expect these levels to explode higher once more. There would likely be a spike higher in bond volatility with some fairly rogue moves on Treasuries. The big winner would likely be the USD as markets move into the safety of the world’s reserve currency. There would also likely be sharp selling pressure on US equities.
US futures would likely sell-off
Looking at the charts of US index futures, we would likely see some significant corrective pressure in a default scenario. The e-mini S&P 500 futures have been stuck under the 4145/4206 resistance barrier throughout 2023. If traders get nervous in the next two weeks, we could easily see the 4062 support being tested.
Probably just as interesting would be the reaction to the resistance band if the Debt ceiling is raised. If this news does not induce an upside break, then it is again likely that the next move would be lower into a correction.
But what about the incredible grind higher that we continue to see on the e-mini NASDAQ 100 futures? The market moves above 13500 yesterday and is within spitting distance of a test of the August 2022 high at 13740. The move is packed with strong momentum and continued buying into weakness within an uptrend channel.
For now, nothing is glaring on the technical analysis to suggest that this move higher will not continue. There is also good breakout support around 13350.
However, I will be keeping an eye on last week’s reaction low at 13202. If this is broken on a pullback, then it would begin to usher in a deeper correction. Furthermore, You can be sure that if this does happen, this will also be accompanied by downside in the S&P futures.
Steve Miley
Co-Founder of TradeDay.
Steve is the former head of Technical Analaysis research at Merrill Lynch and Credit Suisse, and owner of the award winning research boutique Market Chartist.
