Stalled US debt talks, inflation woes hit stocks

By Lawrence White and Koh Gui Qing

LONDON/NEW YORK (Reuters) -World stocks dropped on Wednesday as U.S. debt ceiling talks dragged on without resolution, stoking a general malaise in markets that saw safe-haven assets such as the dollar hold around recent highs.

But crude oil prices bucked the downtrend and kept rising, after a warning from the Saudi energy minister to speculators that raised the prospect of further OPEC+ output cuts.

Negotiators for Democratic President Joe Biden and top congressional Republican Kevin McCarthy met again on Wednesday to end an impasse in talks.

McCarthy said earlier on Wednesday that while there are still differences between Democrats and Republicans over spending, he believed that a deal could be made.

Time is running short for a resolution, and the Treasury Department has warned that the federal government could be unable to pay all its bills by as soon as June 1 - just eight days away - and it would take several days to pass legislation through the narrowly divided Congress.

The U.S. S&P 500 index ended down 0.73% by mid-day, the Dow Jones Index lost 0.77%, and the Nasdaq Composite dropped 0.61%. That helped to drag the MSCI world equity index, which tracks shares in 49 nations, down 1.01%.

"Equity markets are now beginning to fret about the debt ceiling debate," said Nicholas Colas, co-founder of DataTrek Research. "T-bills were way ahead on this call, and they are not yet signalling an all-clear."

Yields on one-month bills, which are being shunned on concerns about payments coming due when the Treasury is most at risk of running out of money, hovered near a record high of 5.8005%.

Benchmark 10-year U.S. Treasury yields, meanwhile, edged down to 3.7361%.

The U.S. dollar index, which measures the currency against six major peers, rose 0.33% to 103.89, nudging further above a two-month high of 103.63 reached last week. [USD/]

The New Zealand dollar dropped 2.3% after the Reserve Bank wrong-footed markets by keeping its forecast for the terminal rate at 5.5%, having hiked by a quarter point to that level.

Europe's benchmark STOXX index fell 1.8% to a 1-1/2-month low, as a jump in UK core inflation and more losses in market-heavy luxury names hurt risk sentiment.

British homebuilders led declines on the FTSE 100 after data showed a closely watched core measure of UK price growth surged to a 31-year high in April, cementing bets of more interest rate hikes from the Bank of England.

Europe's luxury stocks fell 1.7% to a seven-week low as a sell-off in the sector continued.

MSCI's broadest index of Asia-Pacific shares fell 1.1%.

DEBT CEILING DOLDRUMS

Treasury Secretary Janet Yellen said on Wednesday that Biden had offered changes that would result in a $1 trillion reduction in the U.S. deficit, and that there would be some obligations that the U.S. government would be unable to pay if the debt ceiling was not raised.

While the risk of a default that could precipitate a recession is bad for the United States, investors worried about the repercussions for the global economy have turned away from riskier assets.

Reports that Treasury has asked federal agencies whether they can delay upcoming payments added to the sense of crisis.

"Payment prioritisation is now real," Chris Weston, head of research at brokerage Pepperstone in Melbourne, wrote in a client note.

"And while it seems highly prudent to have this conversation, the market's anxiety levels have heated up consequently," he said. "The market is starting to de-risk."

BRITAIN: INFLATION NATION

Euro zone bond yields rose after British inflation data came in stronger than expected, a reminder to investors that the global fight against price rises is far from over.

Germany's 10-year bond yield, the benchmark for the euro zone, retreated from a one-month high of 2.501% struck earlier in the day.

In commodities, gold fell 0.8% to $1,958.8, dragged in part by a firmer dollar.

Interest rate hikes raise the opportunity cost of holding non-interest-bearing gold.

Crude oil price extended gains from Tuesday, when Saudi Energy Minister Prince Abdulaziz bin Salman warned speculators to "watch out", saying "they will be ouching".

Brent crude futures rose more than a dollar to $78.36 a barrel, while U.S. West Texas Intermediate crude (WTI) likewise closed up $1.43 at $74.34 a barrel.