U.S. stocks end lower ahead of debt ceiling vote in Congress despite Fed speakers signaling rate hike pause in June

By Isabel Wang and Frances Yue

U.S. stocks ended lower on Wednesday ahead of a House vote on the federal debt-ceiling deal Wednesday evening to prevent a potential default, but comments from two Federal Reserve officials suggesting the central bank skip an interest-rate rise at their June meeting helped the indices to finish off session lows.

Three major stock indexes finished the month mixed, with the Nasdaq Composite jumping 5.8%, helped by a rally in mega-cap technology stocks. The large-cap S&P 500 index eked out a 0.2% monthly gain while the Dow Jones Industrial Average booked a 3.5% monthly decline, according to FactSet data.

How stocks traded

On Tuesday, the Dow Jones Industrial Average fell 51 points, or 0.15%, to 33043, the S&P 500 increased 0 points, or 0%, to 4206, and the Nasdaq Composite gained 42 points, or 0.32%, to 13017.

What drove markets

Investors will be closely watching a House of Representative's vote on the U.S. debt-ceiling deal expected Wednesday evening which analysts reckon will be passed, but possibly with some delays.

"Even with the positive developments on the debt ceiling front, the equity market is starting to wobble again, and 4,200 on the S&P 500 has yet again proven to have been a ceiling," David Rosenberg, founder and president at Rosenberg Research, wrote in a Wednesday note.

Meanwhile, "it seems like the market is coming to terms with the fact that we're gonna be seeing a liquidity drag as a result of the debt-ceiling deal," said Mike Reynolds, vice president of Investment Strategy at Glenmede.

The Treasury Department will need to replenish cash in the federal government's operating account, now that a debt-ceiling deal is reached. Analysts at Morgan Stanley expected $730 billion in new Treasury bills issuance over the next three months.

"That sort of sucks a little bit of liquidity as a system as the Treasury needs to build back that balance," said Reynolds. "And this is on top of any liquidity suck that comes alongside the continued quantitative tightening from the Fed," said Reynolds. "So it's not just the Treasury replenishing. It's a compounding effect between both the Fed and the Treasury taking liquidity out of the system."

See: Stocks may have put the debt ceiling behind them, but here are more risks to the 2023 market rally

However, U.S. stock indexes recovered some ground late in the session after Federal Reserve officials said it might be appropriate to skip an interest-rate hike at the central bank's next policy meeting in June.

"I am in the camp increasingly coming into this meeting thinking that we really should skip, not pause, but skip an increase," Philadelphia Fed President Patrick Harker said on Wednesday, during a discussion hosted by the OMFIF Economic and Monetary Policy Institute.

Fed Governor Philip Jefferson on Wednesday said that even if the central bank opts to skip another increase in interest rates in June, it would not necessarily mean it is done for the year.

Fed-funds futures reflect a 33.2% probability of a quarter-point hike in the fed-funds rate to a range of 5.25% to 5.5% in June, down from 70% Wednesday morning according to the CME FedWatch tool.

See: Money-market funds own only 15% of the Treasury bill market, but that could change dramatically once Congress passes a debt ceiling deal

Meanwhile, data showed job openings in the U.S. climbed in April to a three-month high of 10.1 million, a sign the economy hasn't cooled enough to forestall more interest-rate increases by the Federal Reserve.

"The U.S. labor market remains tight with nearly 1.8 open jobs per unemployed person, but the declining quit rate could signal weaker bargaining power for workers that could translate to slower future wage gains," said Ronald Temple, chief market strategist at Lazard, in emailed comments on Wednesday.

Temple sees the job openings report as "adding marginally to the case for additional [monetary] tightening" by the Federal Reserve. A strong jobs report on Friday would add to this case further, as the Fed cannot afford to pause prematurely with core inflation well above 5%, he said.

See: Jobs report likely to show further slowdown in U.S. hiring

Investors also seem worried about the limited breadth of equity markets.

The surge in popular mega-cap tech stocks has helped the S&P 500 gain 8.9% in 2023, but much of the market has suffered from worries about stubborn inflation, higher interest rates and a possible U.S. recession. The S&P 500 equally weighted index XX:SP500EW is down 1.7% over the same period.

"A market this much devoid of participation is, in one word or less, dangerous," Rosenberg said.

Earlier Wednesday disappointing data from China showed its manufacturing sector contracting again in May and services activity growing at its slowest pace in four months which triggered a fall in global stock markets.

Hong Kong's Hang Seng lost 1.9%, on edge of a bear market, and Germany's DAX 40 , which is usually sensitive to Chinese growth expectations, shed 0.8%.

See: Hang Seng nears bear market as China manufacturing slows

Companies in focus

-- Jamie Chisholm contributed to this article.

-Isabel Wang

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05-31-23 1640ET

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