Weekly US – Fiscal deal in place

by: Peter de Bruin

Economy I

During the week, Congress reached an 11th hour agreement to lift the debt ceiling, avoiding a potential default, while simultaneously re-opening the federal government. Under the deal, the US borrowing authority will be extended through February 7, while the government will be funded through January 15. Meanwhile, the Treasury will continue to be allowed to use so called extraordinary measures, suggesting that Congress will have somewhat more negotiating room when the US is on the verge of exhausting its borrowing capacity again. The deal leaves in place most of Obama’s health care law, as well as the sequesters. Finally, all furloughed workers will be paid retroactively. While markets responded positively to the deal, it just kicks the can further down the road. Indeed, further negotiations by a bipartisan committee to reduce the deficit, and discuss the fate of the sequester budget cuts, should be completed by December 13, setting the stage of what potentially could be another round of hostile discussions.

 

 Economy II

Meanwhile, we estimate that the reduction in economic output due to the government shutdown will be around $15bn, which – all else equal – should shave around 0.5 percentage points off Q4 GDP growth (annualised rate). That said, the ultimate effects are likely to be less as there will be catch-up demand for government services in coming months. This suggests that the costs of the government shutdown will be relatively modest. Indeed, there has nothing been in the data reports so far that suggests a long-lasting economic fall-out. Granted, initial jobless claims fell more moderately than expected, by 15K to 358K, but claims continued to be affected by a backlog of claims being worked through in California. In addition, the impact from the shutdown on claims, with federal government contractors being affected, should soon fade. Meanwhile, the Philadelphia Fed index fell only marginally to 19.8 in October (was 22.3), though we saw a more marked decline in the Empire State Manufacturing index.

 

 Interest rates

In the beginning of the week, yields moved roughly sideways, but this changed after US Congress reached an agreement to temporarily lift the debt ceiling and reopen the federal government. This boosted demand for Treasuries, as investors no longer feared that a default could lead to a sharp selloff of Treasuries, while expectations of a Fed tapering delay also supported the market. We continue to think that yields will rise to 3% at the end of the year. Indeed, the government shutdown is not likely to have a large impact on Q4 GDP growth, which should allow the economy to accelerate a bit in Q4 and the labour market recovery to gain some momentum. In turn, this should prompt the Fed to begin scaling back its QE programmes in December. That said, the events of the past weeks are likely to make the FOMC cautious, in particular when the coming rounds of budget negotiations prove to be difficult. This risks that a tapering could be postponed until the March meeting, which would lower the trajectory for yields towards the end of the year.