Dollar, European stocks fall with U.S. debt deal Congress vote in focus

By Joice Alves and Scott Murdoch

LONDON/SYDNEY (Reuters) - European stocks and the U.S. dollar fell, after climbing to a two-month high, on Tuesday as relief that the U.S. government had averted a possible default gave way to concern that the deal could face a rocky path through Congress.

Longer-dated U.S. Treasuries rallied as traders welcomed the deal to suspend Washington's borrowing limit until January 2025 in exchange for caps on spending and cuts in government programmes.

But the dollar and European stocks slipped, dented by uncertainty about whether Congress will approve the deal after a handful of hard-right Republican lawmakers said on Monday they would oppose the bill, though it is expected to pass.

Despite the initial risk-on sentiment on the deal announced on Saturday, investors also fear now that the agreement was a compromise that could have negative consequences.

JB Were analysts said there could be up to $600 billion worth of bill issuance in the next six to eight weeks.

The size of the Treasury issuance and the economic implications are now being considered, according to Invesco's Asia Pacific global strategist David Chao.

"The announcement of a debt deal in the near term is a boost to market sentiment but it places pressure on growth due to the government spending cuts, the tighter liquidity conditions. But the flip side is the pressure on growth is doing the job for the Fed as it tries to cool the economy. It could place a dampening effect on inflation."

The pan European STOXX 600 index fell 0.2% after recording on Friday its biggest weekly decline in two months.

U.S. futures were up 0.5% pointing to a start of the day in positive territory for U.S. stocks, which were closed on Monday for the Memorial Day holiday.

U.S. 10-year bond yields dropped 9.7 basis points to 3.72%, while 30-year yields fell 8 bps to 3.89%. Bond yields move inversely to price.

The dollar index, which measures the greenback against six peers, fell 0.26% at 104.03 after rising to a two-month high in earlier trading. It was also trading near a six-month peak against the Chinese yuan.

The yen rose 0.25% against the dollar to 140.08, bouncing back from a six-month low, after Japan's top finance diplomat Masato Kanda said authorities were closely watching foreign exchange market moves and would "respond appropriately".

The Nikkei stock index rose 0.4%, after the Japanese benchmark hit a 33-year high on Monday on optimism over the U.S debt deal and a weaker yen, which helps the country's exporters.

CHINA POST LOCKDOWNS

Hong Kong's Hang Seng Index lost around 6.5% in May while the CSI300 is off almost 5% as a result of China's economy not recovering from its pandemic closures as fast as expected.

The two indexes closed slightly higher on the day after hitting November lows earlier with investors also remaining cautious ahead of China's May manufacturing data due on Wednesday.

"Everyone is looking at the disappointment in the performance of China equities recently and that is now creating negative investor sentiment," said Jack Siu, Credit Suisse's greater China chief investment officer.

"Investors are now more muted towards the reopening story of China and are contemplating their positions."

Elsewhere, euro zone bond yields fell after Spanish inflation data came in lower than expected, raising hopes that the European Central Bank may raise interest rates less than previously feared.

The Turkish lira slipped further to a fresh record low after President Tayyip Erdogan secured victory in the country's presidential election on Sunday.

(Reporting by Joice Alves in London and Scott Murdoch in Sydney; Editing by Simon Cameron-Moore and Chizu Nomiyama)