Markets nervous on debt ceiling uncertainty, US yields rise

Europe's broad STOXX 600 benchmark slipped 0.25%, trading a little below Friday's 15-month intraday high, largely looking through activity data that showed euro zone business growth remained resilient, if a touch softer than expected.

US share futures were broadly flat.

In company news, Julius Baer's shares dropped 7.8% after the Swiss wealth manager reported modest money inflows in the first four months, disappointing investors who had expected it to benefit from Credit Suisse's troubles.

But the overall focus remained on events in Washington.

"The best solution is to have a negotiated settlement that raises the debt limit," said Samy Chaar, chief economist at Lombard Odier. Still, he added some investors were considering the market implications of "a compendium of less dramatic solutions, which may or may not be entirely legal, that might be used to avoid an actual default."

These could include using the 14th Amendment to the US constitution, which states that the public debt of the US 'shall not be questioned' though "That would trigger an inevitable lawsuit, which would go to the Supreme Court to resolve the issue once and for all," Chaar said.

In terms of the actual negotiations, "The resumption of debt ceiling negotiations spurred some hopes, despite distinct risks of brinkmanship and blame-shifting remaining on the cards," said Mizuho economist Vishnu Varathan.

However, "Without real action on that front, hawkish Fed speak has (had) some sway on markets," he said, adding that some pressure on U.S. Treasuries has also lent support to the dollar.

Minneapolis Federal Reserve President Neel Kashkari said on Monday that it was a "close call" as to whether he would vote to hike again or pause at next month's meeting, and St. Louis Fed President James Bullard said another 50 basis points of hikes might be required.

The comments caused traders to push back expectations for U.S. rate cuts from July towards November or December, sending ten-year and two-year U.S. yields to highs not seen since March.

Benchmark 10-year Treasury yields reached 3.7550% on Tuesday, their highest since 13 March, while two-year yields rose around 7 basis points to as much as 4.4040%, also their highest since March.

The US dollar tracked the move and hit a six-month high of 138.88 yen in the Asia session.

"The (Bank of Japan's) ongoing reluctance to tighten monetary policy further in the near-term combined with a recent adjustment higher in US rates has triggered renewed upward momentum for (the dollar versus the yen)," said MUFG senior currency analyst Lee Hardman in a morning note to clients.

The dollar firmed against most other currencies too and traded at $1.0773 per euro.

Oil prices were choppy. Benchmark Brent crude futures were last flat at $76.05 a barrel, while US West Texas Intermediate crude was at $72.14 a barrel, down also little changed.

Spot gold fell 0.7% to $1,955.2 an ounce, as the higher yields hurt demand for the nonyielding previous metal.