Yesterday, the 16-day government shutdown came to an end as Congress passed a bill to the fund government through January 15 of next year and suspend the debt ceiling until February 7. The final bill was relatively clean, as the only provision relating to the Affordable Care Act (which had been the early focus of the conflict) concerned enhanced verification procedures for eligibility.
In addition, House and Senate conferees will be appointed to try to reconcile the two very different versions of the 2014 budget which passed the Senate and House earlier this year. The public is justifiably angry at the process. However, for investors, as always, it is important not to allow political emotions to overrule investment analysis.
With this in mind, a few points are worth noting:
First, while many market commentators will deride this resolution as simply 'kicking the can down the road', the implications of the agreement are a little more complicated. Although the deal only funds the government until mid January of next year, the risk of another government shutdown in January has been diminished. Republicans have suffered in opinion polls as the public blames them more than the Democrats for the government shutdown. Many members of the House and Senate may be reluctant to go down this same road in an election year.
The agreement also wisely kicks the 'debt-ceiling can' a little further than the ‘continuing resolution can’. Assuming both parties avoid another government shutdown, they will very likely decide to further suspend the debt ceiling until after the November 2014 mid-term elections. In short, there is a good chance that we can avoid another showdown of this magnitude in 2014.
Second, it is important to recognize that the 'can' is getting smaller. During the debt-ceiling confrontation in 2011 the U.S. economy was weaker and the budget situation much more severe. The budget deficit in fiscal 2011 was 8.4% of GDP. In sharp contrast, we now estimate the budget deficit to be 3.9% of GDP in fiscal 2013 and it is approaching a level where the debt to GDP ratio should begin to edge down. Despite the political games being played in Washington, the reality is that grumpy compromises have gone a long way to dealing with the nation’s fiscal problems.
It is still the case that the economy needs tax reform and entitlement reform not just to deal with deficits but to enhance the long-term productive capacity of the economy. Investors have every reason to doubt whether the actors in the latest drama are up to this task. However, the American economy has long proven its ability to survive the mismanagement of the officials we elect to direct it and prospects are good that it will continue to do so in 2014, boosting economic output, stock prices and interest rates.
Third, the government shutdown has given an already very dovish Federal Reserve an excuse to further delay tapering at its next meeting on October 30 and it may well decide to wait until its January meeting (and after a new continuing resolution will need to be in place) before commencing a diet for its rapidly expanding balance sheet.
Finally, Standard and Poor’s have estimated that the shutdown may have reduced U.S. output by $24 billion. However, this estimate should not be trusted. The major impact of the shutdown has been in indirect impacts through consumer and business psychology – impacts that are necessarily very difficult to measure. We do know, however, that before the shutdown, the U.S. economy had the potential for modest acceleration due to the lagged effects of rising wealth, an improving global economy, diminished fiscal drag and significant pent-up demand. These forces should reassert themselves in the wake of the crisis.
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