From Westpac’s Elliot Clarke comes a nice primer on the US Government Shutdown and what it could mean for the US economy:
Over a week has past since the US Federal fiscal impasse brought about a partial government shutdown. Little has changed in that time. Overnight a short-term debt ceiling increase proposal was tabled by the Republicans. The intent was to provide a 6-week reprieve from the debt ceiling during which time a long-term solution could be negotiated (i.e. debate entitlement and spending reform). However, President Obama quickly rejected the deal as it would not re-open the government in the interim.
So far, the real activity impact of the shutdown has been limited. Of the 800,000 federal staff initially furloughed, half have been ordered back to work owing to concerns that their absence may impair the proper functioning of the military. Further, the house has approved a bill that will see non-essential staff retroactively paid after the shutdown ends, making the loss of income temporary instead of permanent. However, what we have seen is a deterioration in confidence amongst households and (more recently) market participants; this is sowing the seeds for a much more material real activity impact.
Surveyed last week, the IBD–TIPP economic optimism index fell 7.6pts in October; broad-based concerns over the economic outlook, federal policy and personal finances were the key drivers. The Gallup measure of weekly consumer confidence also saw its second largest fall in the measure’s 5-year history, second only to the Lehman Brother’s collapse. With household consumption growth soft and the housing market under pressure from higher rates, the deterioration in confidence is a very unwelcome development.
Markets are also becoming more unnerved by the fiscal stalemate. This week saw a 1mth Tbill auction awarded at a yield of 0.35% – 6bps above market. 1mth Tbill yields have since edged back, but they remain a multiple of their pre-shutdown level. The rise in short-term yields points to growing angst amongst market participants over a potential market shock. Further, we have also seen reports (WSJ and FT) that some market participants are refusing to accept Tbills that mature next month as collateral for repo transactions. Herein is evidence of the shutdown beginning to have a real impact on the functioning of financial markets and the real economy. (It is also worthwhile keeping in mind that this market uncertainty is hardly supportive of US banks’ credit approval process, which is also being hampered by the FHA and IRS being on skeleton staff.)
For the time being, term yields remain contained, implying the current malaise continues to be seen as a temporary phenomenon. However, absent a circuit breaker, a more material market reaction is only a matter of time. We are now only a week away from 17 October, the date when the Treasury’s extraordinary funding measures are expected to be exhausted, leaving approximately $30bn in cash and new tax inflows as the sole sources of federal funding. The CBO and Bipartisan Policy Center (BPC) both continue to expect the Treasury will find itself unable to meet all payments by 1 November at the latest – when an estimated $67bn in payments fall due. From there on, if a compromise cannot be found, government payments will have to be matched against incoming revenue.
Of more concern, it is entirely possible that some members of Congress may feel they have the ability to stretch the impasse past 1 November in an attempt to see the other party acquiesce. This is because, as long as interest payments are not missed, the US Federal Government will not have been seen to default by the ratings agencies – Moody’s and S&P both seem happy to hold fire unless an interest/principal payment is missed. However, this does not mean that prolonging this disagreement will not have any consequences for the US sovereign rating: Fitch has stated that if the debt ceiling was not raised in a “timely manner”, a “formal review” would be launched “and likely lead to a downgrade”.
While the Treasury may be able to avert ‘default’ by prioritising payments, this would be at the expense of benefit recipients, workers and suppliers. As we highlighted last week, to the extent that 19% of total expenditures were funded by debt in fiscal 2013, the direct effect of a forced reduction in government spending would likely stall the economy in Q4 in and of itself, let alone the indirect impact on household spending and business investment.
For financial markets, even a non-coupon missed payment would be a material confidence shock – and a very unexpected one at that. In effect, receiving payment from the US Federal Government would become a lottery which depended on available revenues, the debt payment schedule and a priority schedule that would likely be in constant flux.
The most likely result remains a last minute compromise. However, both sides seem to increasingly be content with redefining the meaning of last minute. Ergo, it may be very late October (or potentially even early November) before a compromise is found. The potential market and confidence impacts of such a development are certainly worthy of consideration.
