Debt limit deal nearing as spending caps take shape

What’s happened?

Asian shares gained ground today, supported by the strength of the technology sector. However, Chinese stocks bucked the trend and traded lower. Futures in the US and Europe showed a slightly negative bias. The Japanese yen showed marginal strength against the US dollar, hovering near the 140 level. In commodities, Brent crude slipped, while gold prices climbed.

On the energy front, WTI crude futures remained below $72 per barrel on Friday, following a decline of over 3% in the previous session. The main catalyst for the downward pressure on oil prices was Russian Deputy Prime Minister Alexander Novak's resistance to the market's expectation of further production cuts by OPEC+ ahead of the group's scheduled meeting on June 4. Novak's stance contrasted with the warning issued by Saudi Arabian Energy Minister Prince Abdulaziz bin Salman, who cautioned short sellers to be cautious and anticipate potential consequences.

In addition to the conflicting statements from key OPEC+ players, the rising value of the US dollar also exerted downward pressure on oil prices. The dollar's strength stemmed from the resilience of the American economy, which has shown remarkable stability despite the Federal Reserve's aggressive tightening campaign.

Meanwhile, official data revealed a surprising decline in US crude inventories of 12.456 million barrels last week, marking the largest drop in six months. This unexpected drawdown contradicted market expectations of a 0.775 million barrel increase. Despite this positive development, the US oil benchmark is on track to end the week relatively unchanged as Thursday's decline erased earlier gains observed during the period.

As the market eagerly awaits the OPEC+ meeting on June 4, uncertainty surrounding production cuts continues to cast a shadow on oil prices. The contrasting views from Russia and Saudi Arabia, coupled with the impact of the strengthening dollar, have added complexity to the energy market dynamics.

What to watch?

Republican and White House negotiators are making significant progress in their discussions to reach a deal that would raise the debt limit and impose federal spending caps for a two-year period, according to individuals familiar with the matter. The emerging agreement outlines a plan that would allow defense expenditures to increase by 3% next year, aligning with President Joe Biden's budget request. This compromise comes after Republicans set aside their demands for larger spending increases. In a dedicated effort to finalize the agreement, House Minority Leader Kevin McCarthy pledged to work through the holiday weekend. The likelihood is highest for US lawmakers to announce a deal by late tonight or tomorrow.

The release of the April US Personal Consumption Expenditures (PCE) data today may introduce complexities for the Federal Reserve. Headline PCE inflation is expected to have accelerated slightly to 4.3%, while the core inflation rate, which excludes volatile elements, is projected to remain elevated at 4.6%. These figures are partially supported by a tight labor market that has driven income growth. Analysts anticipate both gauges to show a 0.3% month-on-month increase. PCE supercore inflation, which factors out both food and energy components, is expected to remain steady at 0.2%.

The potential implications of the PCE data on the Federal Reserve's monetary policy decisions are noteworthy. The central bank closely monitors inflation metrics to assess the health of the economy and determine the appropriate course of action. If the data indicates persistently high inflationary pressures, it could impact the Fed's approach to interest rates and asset purchases, potentially leading to adjustments in their current accommodative stance.