U.S. stocks and bonds fell on Wednesday as traders weighed the possibility of a U.S. recession from either a U.S. debt default or higher interest rates from the Federal Reserve.

The S&P 500 fell 0.7 per cent, led by losses in financials and real estate, as negotiations over the U.S. debt ceiling stretched into another day and minutes from the Fed showed policymakers split on the path for U.S. interest rates. 

The losses followed stocks in Europe and Asia lower on the day. The Stoxx 600 slid the most in two months as UK inflation came in higher than expected. And in Asia, China’s benchmark CSI 300 erased all its gains for the year as developers’ debt woes and a new wave of Covid added to worries over growth.

Luxury stocks including LVMH and Gucci owner Kering SA extended losses. Chipmaker Analog Devices Inc. slid after a weak outlook on economic uncertainty. And Citigroup Inc. fell after abandoning plans to sell its Mexican unit Banamex.

Yields on short-dated Treasuries continued to push higher, with investors demanding a higher premium on U.S. debt with the highest risk of default. Treasury Secretary Janet Yellen said the U.S. was likely to start missing debt payments as soon as June 1. As such, the yield on securities maturing June 6 pushed above 6.6 per cent on Wednesday while those maturing May 30 are yielding around 3 per cent.

“I’m starting to get the feeling that the Republicans don’t believe in Yellen’s ‘X-date’ and think they have the upper hand,” said Benjamin Dietrich, a portfolio manager at Lazard Asset Management LLC. “I think the risk is for no short-term solution and the S&P breaking lower. Also, the China surprise index collapse should be bad for risk sentiment.”

Despite the threat lawmakers will fail to raise the debt ceiling in time to avoid a financial crisis, bond traders stepped up wagers on a July rate hike following the release of minutes from the Fed’s FOMC meeting in May. Fed policymakers have been walking a fine line, trying not to tip the economy into a recession with its rate hikes in order to clamp down inflation. However, economists project a recession will occur regardless if a U.S. debt deal contains deep spending cuts or there is a default.

“We are pessimistic on the economic outlook,” said Michael Krautzberger, head of EMEA fundamental fixed income at BlackRock International. “The potential volatility coming from the debt ceiling discussion as we approach the deadline is one of those reasons. We don’t expect a technical default but we do expect a last minute deal.”

JPMorgan Chase & Co. Chief Economist Michael Feroli said the odds of U.S. debt talks going past June 1 are 25 per cent and rising. However, Nomura’s Charlie McElligott said he believes a “positive outcome” is getting closer, with traders selling in waves of profit-taking ahead of the Treasury secretary’s deadline.

“Any relief rally on a debt-ceiling ‘deal’ headline into the start of next week then has the potential to act as a local top for stocks for a bit, with most of the ‘wall of worry’ blood already squeezed from the stone,” McElligott said.

Key events this week:

• Fed issues minutes of May 2-3 policy meeting, Wednesday
• Bank of England Governor Andrew Bailey speaks, Wednesday
• U.S. initial jobless claims, GDP, Thursday
• Interest rate decisions in Turkey, South Africa, Indonesia, South Korea, Thursday
• Tokyo CPI, Friday
• U.S. consumer income, wholesale inventories, durable goods, University of Michigan consumer sentiment, Friday

Some of the main moves in markets:

Stocks

• The S&P 500 fell 0.7 per cent as of 4:07 p.m. New York time
• The Nasdaq 100 fell 0.5 per cent
• The Dow Jones Industrial Average fell 0.8 per cent
• The MSCI World index fell 1 per cent

Currencies

• The Bloomberg Dollar Spot Index rose 0.2 per cent
• The euro fell 0.2 per cent to US$1.0751
• The British pound fell 0.4 per cent to US$1.2363
• The Japanese yen fell 0.5 per cent to 139.32 per dollar

Cryptocurrencies

• Bitcoin fell 3.5 per cent to US$26,266.82
• Ether fell 3.3 per cent to US$1,792.69

Bonds

• The yield on 10-year Treasuries advanced four basis points to 3.73 per cent
• Germany’s 10-year yield was little changed at 2.47 per cent
• Britain’s 10-year yield advanced six basis points to 4.21 per cent

Commodities

• West Texas Intermediate crude rose 1.3 per cent to US$73.87 a barrel
• Gold futures fell 0.7 per cent to US$1,979.40 an ounce