A longer shutdown?

by: Peter de Bruin , Nick Kounis

Rising risk shutdown could last for weeks rather than days

The US government shutdown has already extended to four working days and there is a rising risk that it could last for two weeks or more. In particular, developments in Washington have increased the chances that a deal will be struck to end the shutdown and extend the debt ceiling simultaneously, close to the 17th of October ‘deadline’ for the debt ceiling. First of all, on Saturday, Defence Secretary Chuck Hagel ordered most of the 350,000 furloughed civilian defence workers back to their jobs. This would greatly reduce the impact of the shutdown, as it implies that roughly forty percent of the 800,000 furloughed federal workers will return to their workplace. But, unfortunately, it also reduces pressure on both Democrats and Republicans to re-open the federal government quickly. Indeed, at the time of writing, positions seemed as entrenched as ever. On Sunday, John Boehner, the Republican Speaker of the House of Representatives, called his party to ‘arms’ saying it was ‘time…to stand and fight’. He said that his party was not willing to pass the bills necessary to either fund the government or raise the debt ceiling without concessions from the Democrats. Top of the list remains changes to the Democrat healthcare policy widely known as Obamacare. On the other hand, Democrats insist Mr Boehner brings a ‘clean’ government funding bill before the House, arguing that moderate Republicans would help to get it through. At the same time, President Obama refuses to negotiate on concessions.

Congress may go for a double deal

Finally, as the shutdown goes into its second week, the 17th October debt ceiling deadline increasingly nears. Passing the new continuing resolution in Congress, due to procedural hurdles, could easily take a week, suggesting that there will be little time left to deal with the much more important debt ceiling. As we continue to think that neither Democrats nor Republicans want to risk the debt ceiling not being raised on time, this makes it increasingly likely that Congress will be forced to deal with both fiscal disputes at the same time. Although the politicians could surprise us and move swiftly to break the deadlock, we are not holding our breath.

Long shutdown could further delay the Fed´s tapering

All this suggests that it is starting to look likely that we are heading for a protracted government shutdown, possibly for as long as three working weeks. Although the return to work of the Pentagon´s civilian workers has reduced the economic costs of the shutdown, a three week shutdown still would shave around 0.5 percentage points or so off Q4 GDP growth. In terms of our own base scenario, this would suggest that growth comes in at around 2.5%, instead of our existing forecast of 3%, implying that the economy failed to accelerate meaningfully in Q4. Together with a negative fall-out on confidence indicators, and possibly even some softer labour market figures, because of the fiscal mess, there is a growing possibility that the Fed will further delay tapering its asset purchases. Indeed, while our base case continues to expect a December move, the risk of a March 2014 taper has risen significantly.

Possible Fed delay points to risks to our forecasts

It logically follows that there are downside risks to our year-end US Treasury yield and dollar forecasts. However we would not see any lasting impact on the economy or financial markets, as long as the debt ceiling is raised, even at the eleventh hour. So even under a longer shutdown scenario, we would not fundamentally change our calls on the underlying trends for the US economy and the implications for rates and currencies in 2014.