Fed Rate-Hike Odds Are Falling. Debt Limit Talks Are Going to the Wire.

At the same time, U.S. government bond yields were retreating. The yield on the 10-year Treasury was down 0.3% at 3.65%, and the yield on the two-year note was down 0.3% at 4.24%. Yields move inversely to prices. 

It remains unclear whether the U.S. will actually default on its bonds if the debt ceiling talks fall through. It’s also not obvious how precisely the market would react. On the one hand a credit event should drive up bond yields as investors seek compensation for uncertainty. On the other hand, the Fed would have to react, possibly by cutting rates, which should lower yields. Additionally, U.S. bonds are traditionally havens in times of turmoil, which would also create downward pressure on yields.

For some strategists, all that suggests the yield-curve inversion would get even steeper–the short-term yield would go even higher than the long-term if the U.S. stops paying its debts. Yield inversions are traditionally considered early warning signs of recession. The inverted curve was also a big factor behind the banking turmoil that brought down Silicon Valley Bank and others earlier this year.

President Joe Biden and Congressional leaders are scheduled to meet again today to discuss the debt ceiling. Treasury Secretary Janet Yellen has said the government won’t be able to meet its financial obligations on or very soon after June 1, or Thursday next week.

Republicans in Congress are demanding deep spending cuts in exchange for agreeing to raise the amount of money the U.S. can borrow. Biden and fellow Democrats insist such discussions should take place in the normal budgeting process, not when the U.S. needs to pay for what Congress has already agreed to spend.

The next Fed decision is due June 14.

Write to Brian Swint at [email protected]