Markets struggled for direction Tuesday as traders weighed prospects for a slowdown in the pace of U.S. rate hikes against data that suggest tighter policy may be needed for longer.

Contracts on the S&P 500 wavered following a third day of declines for the index on Monday. Futures on the Nasdaq 100 fluctuated in a narrow range. A gauge of European equities turned lower as a seven-week rally lost steam. Treasury yields dipped along with the dollar.

A resilient U.S. economy and sticky inflation are countering optimism about a reopening in China, with money market futures and economists suggesting the Fed will need to push rates to a higher peak than previously expected.

"Central banks will likely continue to have an outsize impact on stocks in December," said Kristina Hooper, chief global market strategist at Invesco. "In addition, lowered earnings revisions could exert downward pressure on stocks. Therefore, I expect significant volatility for the month, although the bias is likely upward given historical trends."

The S&P 500 remains on course for its biggest fourth-quarter gain since 1999, but has lost some momentum in December after a stellar rally. The benchmark index has now slipped about 2% so far this month.

Bond yields paused their ascent, with the yield on 10-year Treasuries slipping about three basis points to 3.55%. Strong U.S. services data Monday fanned speculation for higher rates, pushing the benchmark yield past 3.5%.

Swaps showed an increase in expectations for where the Fed terminal rate will be, with the market indicating a peak above 5% in the middle of 2023. The current benchmark sits in a range between 3.75% and 4%.

Fed officials, now in their pre-meeting blackout, have strongly suggested they would downshift to a half-point move at their Dec. 13-14 gathering, after four straight 75 basis-point increases. They've also said they likely will need higher rates than they thought in September, when the median forecast saw them at 4.6% next year from a current target range of 3.75% to 4%.

Meanwhile, Beijing announced it will scrap COVID testing requirements for most public venues in what is seen as a move toward the exit of COVID Zero policy.

"Risk assets may enjoy some degree of positive momentum from Asia, if developments continue to fuel optimism about a 2023 Chinese reopening," rates strategists at Mizuho International Plc wrote in a note to clients.

Elsewhere, a majority of 291 respondents to the latest MLIV Pulse survey said leveraged loans would be the canary in the coal mine to indicate that corporate credit quality is getting worse.

About 28% of survey respondents expect defaults to jump significantly if U.S. rates peak at or below 5%, which is about where the market bets the Fed will stop hiking. Another 63% see defaults surging if rates peak above 5%.

Cecile Gutscher reports for Bloomberg News.

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