Readers will know that I’ve been sanguine about the implications of the US shut down for markets. I remain so, largely. However, there is another risk emanating from the Washington impasse that is more enduring. To understand it, here is the take of Westpac’s rising US star, Elliot Clarke:
The US congress has failed to reach an agreement on a new spending authority. The immediate consequence is a partial shutdown of US Federal government authorities, with some 800k employees set to stay home without pay until such time as a compromise is found. The release of key data will also be delayed, most notably Friday’s employment report. The Republicans remain resolute in their desire to forestall the introduction of Obama’s new health care initiatives, while the Democrats have an equally strong resolve to not allow a delay of this key policy. Hence, it is not at all clear when and how a resolution will be found.
In and of itself, the passing of a new spending authority should have merely been a procedural matter. That it has turned into such an ordeal emphasises the hostility between the two parties, and raises material concerns over the likely conclusion to the much more important debt ceiling debate, set to come to a head in the next fortnight.
In a letter to Congress last week, Treasury Secretary Jack Lew stated that “Treasury now estimates that extraordinary measures will be exhausted no later than October 17 [and]… “at that point, Treasury would only have approximately $30 billion to meet our country’s commitments”, in addition to new revenue inflows.
The CBO’s key expenditure timeline highlights that the $30bn in available funds will be exhausted quickly. According to the CBO, $12bn in social security payments are due on 23 October, and a $6bn interest payment is due on 31 October. 1 November is most likely to be the first day when the Treasury would not have enough cash on hand to meet expenses due, with an estimated $67bn in outgoings. From there, expenses could only be paid as cash became available. That daily tax receipts average approximately $7bn while a single day’s expenses can be as high as $60bn emphasises the degree of volatility in public spending and financial markets that a shutdown could create. Whether Treasury would prioritise certain payments over others is yet to be discussed openly, although given the rating implications, interest and principal payments would arguably take priority. The key date for interest payments is 15 November, when around $30bn is to be paid to Treasury holders.
It is important to note that authorities have stated that there are no additional fall back funding facilities or legal workarounds available should the debt ceiling not be raised.
To the extent that we have never been in a situation where the debt ceiling has not been raised, there is a high degree of uncertainty over how events will transpire. That said, what is plainly evident is that a protracted stalemate would have a significant impact on the US economy. In fiscal 2013, around 19% of total expenditures were funded by debt issuance; and, as at June 2013, direct Federal Government spending was equivalent to 7.5% of GDP (excludes transfer payments to state and local governments).
While it is hard to believe that either the impasse over the spending authority or a potential follow-up crisis around the debt ceiling would last for weeks, they are still shocks which the US economy can ill afford. As we have highlighted at length, the US economy is in poor health, with growth unable to break above a sub-trend pace. Of late, we have already seen leading indicators of business investment moderate. Consumer confidence has also ebbed, and consumption growth remains soft, particularly the crucial services sub component. Taper talk and the associated rise in mortgage rates have also weakened the housing market. We anticipate growth will maintain an annualised growth pace of 1.7% in Q4 absent a shutdown, so a delay of more than a few days could see the US economy verge on stalling. Further, the direct and confidence-related impact of a shutdown at this juncture could linger well into 2014.
This then leads to a discussion of a likely eventual conclusion to this malaise. Obama’s health care initiatives are clearly not up for negotiation, and entitlement reform will likely prove too complex and too politically sensitive a year out from the next mid-term election. Head-strong republicans are therefore most likely to (eventually) turn to a further sequester to claim a ‘win’ from these negotiations. These new cuts would be in addition to those that have already been legislated, the impact of which will persist into 2014. It is hard to estimate the scale of any further cuts. The Budget Control Act’s $110bn agreement arguably provides the best guide to a maximum possible scale. Cuts of this magnitude would be equivalent to 0.7ppts of GDP. We currently see year-average 2014 growth of 1.7% without further cuts, so such an agreement would see the US economy under considerable distress throughout 2014. This would put the recovery at risk, and force the Fed to maintain its highly accommodative stance. Developments in Washington bear close watching.
In short, one possible outcome of the negotiations is increased US austerity for the 2014 year. That is a nasty risk for Australia. It’s not the impacts on US growth directly that matter so much as it is the impacts upon US monetary settings. Increased US austerity will almost certainly result in a cancelled taper of monetary policy. That, in turn, will fire up a renewed round of “risk on” capital allocations, the US dollar will come under pressure once more and commodity currencies will find themselves rising on revitalised hot money flows.
A higher dollar is the last thing Australia will need and with a housing blowoff loose in Sydney and threatening in Melbourne, monetary policy will be unable to react, again, as another round of tradable hollowing out takes hold. This will be as bad for mining as it is for non-resource exports as its own reckoning on slowing Chinese demand and oversupply gathers pace.
It’s a picture fraught with danger for Australian imbalances.
