The fiscal tragedy playing out in our nation's capital will have real consequences, both intended and unintended, in the days, weeks, and months to come. At issue are two critical elements: the federal budget and the debt ceiling. While these are two distinct and separate concerns, the political climate is such that neither topic will likely be resolved before their respective deadlines.
First, let's look at the federal budget. Just as our families and businesses operate within the confines of a budget, the federal government does, too. Its spending year begins October 1st, so having a budget agreed upon before that date is critically important. Without a budget, the government shuts down all non-essential services, such as mail service, various services in the departments of labor, education, FDA, etc. Other categories are essential, for instance, the military and air-traffic control for airports, and therefore won't be immediately affected. Within these non-essential areas are roughly 900,000 employees, so they will be temporarily laid off. Until the House and Senate pass legislation - and the President signs it - the shutdown will continue. One of the ramifications of this shutdown is that government reported economic data will not be released. Therefore, the jobless claims and payroll report, and updates on consumer spending and inflation, will be delayed. Investors rely on this information to gauge the strength of the economy and labor market, so without it, we're in a bit of a vacuum.
It's difficult to estimate how long the shutdown will continue. The last shutdown occurred in late 1995 for a short time, then a month later, after a stopgap measured passed, continued for several months. At the heart of this showdown is the Affordable Care Act - a divisive wedge between Republicans and Democrats that is quite large and unlikely to be overcome easily. The economic effect of the shutdown is equally difficult to assess. Sequestration has already put downward pressure on government spending, so a further reduction in federal spending won't be as large as it would have been prior to sequestration. However, private spending - by businesses and individuals - may decline should the shutdown extend beyond a few weeks as confidence erodes. In sum, growth in the economy could be reduced by roughly 1%, assuming a relatively quick resolution.
Second, let's look at the debt ceiling. Going back to our budget discussion, when expenses exceed revenue, one must borrow money (or sell equity) to make up the shortfall. The cumulative borrowings for the US government are currently $16.7 trillion. We reached this Congressionally mandated level back in May, so the Treasury Department has been using extraordinary measures to keep from breaching the ceiling. However, these measures only last for so long, and Treasury has now estimated that by October 17th those measures will be exhausted. If the debt ceiling is not raised, the federal government will not be able to meet all of its obligations. Now, a family may be able to choose which bills it wants to pay; maybe the mortgage and car payments are made today, but the cable and phone bills get pushed off until the next paycheck. The federal government could do the same, but it would be politically challenging to prioritize payees and would result in a technical default, likely triggering a ratings downgrade and volatility in markets. In 2011, Congress raised the debt ceiling and averted a default, though Standard & Poor's downgraded US debt to AA+.
Investors generally don't like uncertainty and will sell riskier assets such as stocks and buy safer securities, such as Treasury securities. For the past week or two, this has been the case. However, Treasuries maturing near the October 17th deadline have been more volatile. The closer we come to the 17th, and especially if a budget has not been passed, markets may become more volatile and short term Treasuries may decline in value.
We expect Congress to raise the debt ceiling, though again the timing is uncertain. As such, we continue to purchase and hold Treasury securities in client portfolios.
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