LONDON— Signs of a deal to avert an economically damaging U.S. debt default boosted world equities and the dollar on Tuesday, though firm short-term interest rates highlighted concerns that the problem may just be postponed.
Hopes of a deal rose after U.S. Senate Majority Leader Harry Reid, a Democrat, and his Republican counterpart, Mitch McConnell, ended a day of talks on Monday, with Reid saying they had made “tremendous progress.”
While markets remain wary over the eventual outcome, the signs of a last-minute compromise were enough to lift Europe's blue chip index, the Euro STOXX 50 to a 2-1/2-year high and sent shares in Asia to five-month highs.
U.S. stock index futures signaled a mixed start on Wall Street with a weak earnings report from Citigroup likely to pressure the broad S&P 500 index which is lying just below a record high.
“The consensus is bullish, everyone believes that a deal will be reached,” said Guillaume Dumans, co-head of research firm 2Bremans.
The gains around the world lifted MSCI's world equity index, which tracks shares in 45 countries, by 0.15 percent, leaving it just three points away from a five-year high hit in September prior to the crisis in Washington.
However, the reaction in the U.S. Treasury bill market was more muted as sources close to the negotiations revealed that the plans under discussion may only free the government to borrow more money to fund itself until mid-February 2014.
U.S. Treasury one-month bill yields were yielding around 20 basis points, down 5.5 bps on the day but well up from 2.5 bps on Sept. 30 just before the fiscal deadlock in Washington forced the government to begin a partial shutdown.
“There seems to be some progress being made but the solution that is being proposed is far from perfect. It's short-term, it's just pushing the problem further along for a few months,” Philip Tyson, strategist at ICAP, said.
The dollar shared some of the optimism over the prospects of a last-minute deal emerging this week, gaining 0.5 percent to hit a one-month high against a basket of major currencies .
Against the safe-haven Swiss franc, the dollar was also at a one-month peak, at 0.9160 francs, but it was little changed versus the yen, another refuge in times of uncertainty, at 98.50 yen.
The gains in the dollar may be limited as the government shutdown is expected to have hurt the U.S. economic recovery, and has convinced many that the Federal Reserve will have to extend its monetary stimulus into next year.
“If we get some kind of temporary resolution in the U.S. it will still have a small positive short-term impact on the dollar. But in the medium term this is clearly dollar-negative,” said Richard Falkenhall, currency strategist at SEB.
Elsewhere in the currency market, the Australian dollar jumped to a four-month high when minutes of the central bank's October 1 meeting revealed it was prepared to cut interest rates further though it was in no hurry to act.
In Europe an unexpected rise in German analyst and investor sentiment lifted the outlook for the region's largest economy.
The influential ZEW Institute's monthly poll of economic sentiment rose to its highest level since April 2010 and beat a Reuters poll forecast for no change.
The ZEW data had scant impact on the euro, however. It was down 0.5 percent at $1.35, near the bottom of its recent range trading band of $1.35 to $1.36.
German 10-year government bond yields were at their highest levels in three weeks, up 3 basis points at 1.89 percent , though most of the move came before the ZEW data.
A separate report on price pressures in Britain showed inflation was higher than expected in September and house prices had risen sharply, adding to doubts over how long the central bank can hold down interest rates.
Gold, whose safe-haven appeal is usually burnished during times of uncertainty, fell to a fresh three-month low. It shed 0.8 percent to $1,262 an ounce.
Oil prices gained some support from the encouraging U.S. budget negotiations but were under pressure from talks in Geneva over Iran's nuclear program that might eventually lead to a pick-up in Iranian oil shipments.
Brent crude futures were trading down 83 cents at $110.26 a barrel at 1215 GMT, after ending lower in the two previous sessions.