Equities drifted lower due to a combination of concerns over the debt ceiling in the US and ongoing inflationary pressures. Although headline consumer price inflation (CPI) continues to slow across the globe, it remains at levels that make central banks uncomfortable. Inflation data in both the US and the UK disappointed and led investors to sharply reassess the forward path of interest rates.
In the UK headline CPI for April slowed sharply to 8.7% from 10.1% but exceeded the Bank of England’s estimate for the third month in a row. More importantly core inflation jumped from 6.2% in March to 6.8% in April. This led markets to price in a further 25bps rise in interest rates to 4.75% at the meeting of the Bank’s monetary policy committee.
Headline and core inflation also rose faster than expected in the US and led to a similar reassessment of rates. The Fed funds futures market also now sees the prospect of a rate cut this year as being evenly balanced, compared to the 75bps of rate cuts expected as recently as mid-May. The persistence of UK inflation led to further appreciation in Sterling.
Despite the shrill rhetoric from both sides, the Democrats and Republicans reached a bipartisan agreement to suspend the debt ceiling and avert a potential default by the US government. In return for suspending the $31.4m trillion debt ceiling, the Democrats agreed to cut some elements of government spending. Although an agreement was ultimately expected it removes a tail risk for financial markets.