HIGHLIGHTS OF THE WEEK

  • Not even a looming government shutdown could dampen market optimism this week. More evidence of strong momentum in the economy saw equities gain ground, while Treasuries and the U.S. Dollar continued to fall.
  • It remained a coin toss at time of writing whether Congress will reach a funding deal to avert a government shutdown at midnight. If government shuts down, many non-essential services won’t operate, and employees will not be paid.
  • For markets, shutdowns have been modest negatives in the past. However, markets rallied in the last three. All told the U.S. economy has very solid momentum heading into 2018. A closure would be a slight hit to growth, but not derail the U.S. expansion.

 


Headed for a Shutdown?


Not even a looming government shutdown could dampen market optimism this week. Equities continued to rally, and Treasury yields rose as the bond market becomes increasingly convinced that the improved momentum in the global economy is for real, and that inflation pressures may be starting to build.

As for that looming shutdown, the House passed a stop gap spending bill that would fund the government until February 16th, but it faces an uphill battle in the Senate. Any continuing resolution to fund the government needs 60 votes in the Senate, and the GOP only has 51 seats so it needs Democratic votes. Dems are opposed to the bill because they want it to deal with the fate of “Dreamers” – people who were brought to the U.S. illegally as children – whose protection from deportation expires in March. Congress has until then to pass a bill to address the Dreamers, but Dems are trying to use their leverage in the Senate to force the issue now. It is a political game of chicken, and at time of writing it is unclear whether a compromise can be reached by midnight tonight.

So, what happens if they don’t reach a deal? Well, we have a fair bit of experience with shutdowns – there have been 18 “funding gaps” since 1976, and three full shutdowns. The most recent shutdown in 2013 led to about 40% of federal government workers being furloughed, the equivalent of about 850,000 people.

In the event of a shutdown, essential services will remain in place, including roles like air-traffic controllers, armed forces, and law enforcement. The Federal Reserve is not funded by Congress, so it too would remain open for business. But, many “non-essential” operations would be closed, like national parks, statistical agencies and the IRS, causing disruption in the lives of many Americans, particularly those federal employees who will not be paid during the shutdown.

This would have a negative effect on growth in Q1. The Bureau of Economic Analysis (BEA) estimated that the last 16-day shutdown lowered real GDP by 0.3 percentage points (annualized) in Q4 2013. If the shutdown were to drag on, for example, for four weeks, it is estimated it would lower real GDP growth by 1.5 percentage points (annualized). Right now, first quarter growth is tracking just shy of 2 ½% annualized, strong enough to withstand the hit. 

In the past, shutdowns have not been catalysts for market downturn. On average, markets have shown modest weakness, with the S&P 500 down 0.6% over the period of the closure. However, the index rose in 44% of past government shutdowns. In fact, during the last three, under Clinton & Obama, markets rallied. Given current market optimism on strong global growth, it seems unlikely that a shutdown would derail the rally.

Markets do have solid economic reasons for optimism. Next week we see the first estimate of fourth quarter growth. We expect the U.S. economy ended 2017 with solid momentum at a near 3% annualized pace (Chart 2). That would corroborate the recent Beige Book, which showed widespread momentum across the country.

Leslie Preston, Senior Economist


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