Macro Viewpoint
Q&As on next episodes of the US
fiscal soap opera
Johnny Bo Jakobsen
US Chief Analyst
Global Macro
+45 3333 6178
@jbjakobsen
[email protected]
Nordea Research, 23 October 2013
• Once again Congress has merely kicked the can down the road for a few
months.
• However, we believe that the next episodes of the US fiscal saga will
prove much less disruptive than the drama that just ended.
• The reason is that the political costs of the recent brinkmanship seem
very high. The breakdown of the Republican Party unity opens the
possibility for more bipartisanship in the next episodes of the fiscal soap
opera on Capitol Hill as we get closer to the 2014 mid-term congressional
elections.
• We expect the after-effects on the economy of the recent fiscal drama to
be relatively modest and short-lived.
• We therefore still expect the Fed to start tapering at the January FOMC
meeting but acknowledge that a later move is more likely than one
sooner.
As the dust settles after last week’s budget agreement, which merely kicked
the can down the road for a few months, the key question is whether a new
disruptive fiscal showdown is looming on the horizon. Despite the recent
reckless behaviour in Congress we are actually rather optimistic, although
some uncertainty is likely to creep back into financial markets as we get
close to the next deadline for raising the debt ceiling, probably in mid-March
at the earliest.
In this note we provide some updated thoughts in Q&A form on the next
episodes of the continuing fiscal soap opera in Washington DC.
What are the next important deadlines for US fiscal policy? And how
are the risks posed by these deadlines?
Last week’s fiscal agreement to end the government shutdown and suspend
the Treasury debt ceiling sets three new deadlines.
First, another joint House-Senate conference committee will be formed and
is supposed to come up with a fiscal budget bill that appropriates funding for
fiscal year 2014 by 13 December 2013.
Contents
However, considering the differences between the budget resolutions passed
by the two chambers earlier this year, a grand bargain on the budget seems
rather unlikely at this juncture. Democrats seem unlikely to agree to any
significant savings on entitlement spending (Social Security and health care)
without increased tax revenues as well, and Republicans seem unlikely to
agree to increased revenues.
How will the recent fiscal drama
impact the economic outlook? . 3
A more realistic possibility is that the new bi-partisan committee agrees to
offset some of the new USD 19bn (0.1% of GDP) sequester-related federal
spending cuts, which are scheduled to occur after 15 January 2014, with
other savings spread over the next several years. Because the new sequester-
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What are the next important
deadlines for US fiscal policy?
And how are the risks posed by
these deadlines? ....................... 1
What are the implications for the
monetary policy outlook?.......... 4
What would make us reconsider
the forecast that tapering of QE
will start in January? ................. 4
Q&As on next episodes of the US fiscal soap opera
related cuts are more than accounted for by defence spending, some
Republicans agree with Democrats that these cuts should be replaced.
The
13
December
deadline is not crucial
Anyway, lack of agreement on a budget by 13 December would have no
immediate consequences, and as a result this first deadline is unlikely to
generate a great deal of uncertainty.
Low risk of new
government
shutdown
after 15 January
Second, the continuing budget resolution, which was passed last week to end
the government shutdown, expires on 15 January. Without a new agreement
by then, the government will shut down again. However, at this point we
believe the risk of a new shutdown is low.
Very high political cost
of shutdown
First of all, the Republican leadership appears to agree that the political costs
of the recent political brinkmanship were very high. Thus, a recent Gallup
poll found that the Republican Party approval rating has fallen to 28%,
marking the lowest rating Gallup has ever registered for a political party.
Against this background Senate Minority Leader Republican Mitch
McConnell has said that another shutdown in January is unlikely. True,
McConnell doesn’t speak for the Conservative fringe of the Republican
Party. But the cost of the recent irresponsible escapade seems so high that
the Republican leaders likely realise that they would risk losing the majority
in the House of Representatives in the November 2014 mid-term
congressional elections if they tried a shutdown again.
A lot of what happens in Congress between now and the mid-term elections
will be posturing for votes.
Breakdown of Republican Party unity opens the
possibility for more
compromise
We were also pleasantly surprised to see that no less than 114 Republican
votes eventually supported the clean bill to temporarily finance the
government and lift the debt ceiling. That was 87 votes in the House or 38%
of the House Republican caucus and 27 votes in the Senate or 59% of Senate
Republican caucus. By way of contrast, the Affordable Care Act, often
referred to as Obamacare, was passed in 2009 without a single Republican
vote.
The breakdown of the Republican Party unity opens the possibility for more
bipartisan compromise in the next episodes of the fiscal saga on Capitol Hill.
Moreover, by January next year Obamacare will have taken full effect. As a
consequence, it is unlikely to be an obstacle to the next extension of the bill
to temporary finance the government to the same extent it was during the
Bumping against the debt ceiling
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Q&As on next episodes of the US fiscal soap opera
debate that just ended.
Debt ceiling suspended
until 7 February
Third, last week’s budget deal suspended the USD 16.7trn debt ceiling until
7 February. The amount of debt issued by the Treasury while the debt
ceiling is suspended will be added to the ceiling from 7 February onward. As
with earlier episodes, once the ceiling is reinstated the Treasury will then be
able to use “extraordinary measures” to keep raising cash for a while after 7
February. (The standard set of extraordinary measures includes halting new
investments in federal employee retirement funds and suspending issuance
of non-marketable state and local government securities).
Final deadline to raise
debt ceiling is probably
mid-March at the earliest
As a consequence, the final deadline to raise the debt ceiling to avoid a
government default is probably in mid-March at the earliest. Depending on
tax revenues, tax refunds and dividends from Freddie Mac, the final deadline
might be pushed into May or June, even closer to the election season.
For the same reasons mentioned above, we are hopeful that the recent
experience will discourage political brinkmanship so that the next debt
ceiling increase will prove less disruptive than the most recent one. However,
some uncertainty is likely to creep back into financial markets as we get
close to the final deadline.
Government
default
seems very unlikely
Still, a total blow-up with a US government default seems very unlikely.
While around 30 Tea Party-aligned Congressional Republicans believe that a
US government default is not a bad thing (so-called default deniers), most
Republicans will not allow a default.
The debt ceiling weapon is simply so toxic as to be unusable.
How will the recent fiscal drama impact the economic outlook?
Outlook more uncertain
than usual
Lack of economic data due to the government shutdown obviously makes
the economic and Fed outlook more uncertain. However, we expect the
after-effects on the economy of the fiscal drama that just ended to be
relatively modest.
So far the most noticeable impact of the political turmoil has been on
consumer confidence indicators, which generally have weakened
significantly. Encouragingly, however, financial markets generally took the
debate more in stride than in prior episodes and the S&P 500 is now at a new
record high.
Over the coming weeks we expect to see some negative impact on economic
Wall Street much less worried …
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… than Main Street
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Q&As on next episodes of the US fiscal soap opera
data of the fiscal drama, but we don’t expect that to be long-lived. Thus,
because of the damage resulting from the shutdown itself as well as the
uncertainty among households and businesses created by the political
brinkmanship, we have already cut our Q4 GDP growth forecast from 2.8%
to 2.5%. However, in Q1 2014 we expect GDP growth to pick up to 3.2%.
Broad story unchanged:
on the verge of a selfsustaining recovery
Looking ahead, the broad story is unchanged. The economy is on the verge
of stronger growth, more jobs and lower unemployment. The reason is that
over the past four years, since the recovery started, the private sector has
made significant improvements. Business balance sheets are about as strong
as ever, the banking system is well capitalised, households have significantly
reduced their debt loads and financial conditions are very lenient.
As the drag on growth from fiscal tightening gradually fades, the still fragile
recovery will likely soon become a self-sustaining expansion – if sanity
returns to Washington in line with our expectations.
Biggest risk: Washington
politics
For now, however, Washington politics is the biggest risk to the US
economy.
What are the implications for the monetary policy outlook?
No tapering this year
As long as it is still unclear what economic damage the fiscal drama has
caused, the Fed is unlikely to begin tapering its bond purchases (QE).
Moreover, with last week’s budget agreement merely kicking the can down
the road for a few months, uncertainty around fiscal policy is likely to
remain a reason to withhold tapering, just as it was at the September FOMC
meeting.
We still expect tapering
not to
begin until
January
However, by the 28-29 January 2014 FOMC meeting we will know if
another government shutdown has occurred. We expect not, and as a
consequence we believe the Fed will start tapering at this meeting. For now,
however, a later move seems more likely than a sooner one.
What would make us reconsider the forecast that tapering of QE will
start in January?
Labour market performance will be decisive
for the Fed
The Fed’s key criterion for changing its policy is clear evidence of a
sustained improvement in the labour market outlook. Such clear evidence
might not be available this year because the government shutdown depressed
employment in October and will probably cause a corresponding bounce
back in November.
Threshold:
probably
175k average gain in
payrolls
However, if the underlying trend points to significantly weaker payrolls
growth than around 175k per month over the next few months, the Fed will
probably delay tapering until March or April.
True, an average 175k rise in payrolls would be somewhat stronger than the
recent reported trend even before any negative effects from the fiscal drama
kick in. Thus the average gain in Q3 was 143k, down from 195k in H1.
However, we note that payrolls gains have recently tended to be
undercounted initially. For the 12 months through August, first prints
averaged 161k versus 185k in the currently reported data.
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Q&As on next episodes of the US fiscal soap opera
Moreover, if our assumption that the next episodes of the fiscal saga will be
much less disruptive than the recent drama proves wrong, the Fed’s tapering
decision would likely be delayed well into 2014.
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