Any compromise is likely to last only for a few months
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On September 25 the speaker of the U.S House of Representatives , John Boehner, announced that he would step down from his post at the end of October. The trigger for Mr. Boehner’s departure was a threat by conservative Republicans to derail a government funding bill if it did not explicitly defund the Planned Parenthood agency .
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The likelihood of this leading to a government shutdown this week is however very low. Speaker Boehner’s announcement will likely free him and the Republican leadership in the House to bypass the Tea Party elements in the House and work with most Republicans and Democrats to pass a Continuing Resolution (CR) in the next couple of days that extends spending authority for at least 60 days (into early December). The Senate will likely agree to this and the President will likely sign.
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The bigger question, and looming uncertainty, hinges on how things will play out as year-end approaches. If the CR lasts only into early to mid-December, and does not contain an increase in the debt limit (both of which seem likely), we will face increased risks as we head towards year-end – not only of a possible budget impasse/government shutdown, but also a deadlock over raising the debt limit. This will likely have to be raised by mid-December at the latest (possibly earlier), though the date is somewhat uncertain, pending incoming revenue and spending figures and also some accounting maneuvering that the Treasury could employ.
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There are many ways this could all play out that are hard to rank at this point; the situation bears an eerie resemblance to the impasse that shut the government down in 2013, though a repeat of that seems less likely this time, not least because that event clearly hurt the Republicans politically, something they would presumably be keen to avoid repeating heading into the 2016 election.
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In summary, political uncertainty may diminish in the very near term but a budget/debt limit impasse in December is a risk.
Markets relaxed for now but tail risks remain
The immediate impact of this dispute on the U.S. economy and markets is likely to be very limited. However, if by year-end budget/debt limit disagreements appear increasingly unfixable, then this could become the “wrong event at the wrong time”. Markets, particularly if they were already unsettled by other concerns (e.g. China) could use the threat of a government shutdown to become increasingly risk averse. Note that the 16-day shutdown in 2013 shaved around 0.1-0.2% from gross-domestic-product (GDP) growth and added about USD2bn to the government budget deficit that year.
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Equities: A political impasse could contribute to general uncertainty and volatility in the U.S. equities market. However, the impact of any future government shutdown on U.S. corporations would likely be limited: the 2013 experience suggests that negative effects via reduced government employee disposable incomes, disrupted government contracts and so on are largely reversed as the government machine ramps up again at the end of the shutdown.
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Fixed Income: We do not see this political dispute as likely to have an immediate impact on either the 88 market or the Fed ’s “lower for longer” approach. However, a failure to raise the government debt limit would constitute a tail risk, in that it might threaten to disrupt the supply of and market for U.S. Treasuries . During the last government shutdown in 2013, the Fitch ratings agency placed U.S.-AAA ratings on “rating watch negative” and there was some concern about the implications of a default; however in the event there was a flight to quality and there was no widening in U.S. yields. While we do not expect a major problem, remember however that yields rose in the run-up to the 2011 debt crisis after Standard and Poor’s (S&P) announced a negative outlook on U.S. debt in April 2011. (Yields fell back after the raising of the debt ceiling in August 2011, despite the subsequent S&P rating downgrade.)
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Currencies: This is currently not a big issue on currency markets. However were risk aversion to grow, a U.S. government shutdown would not be helpful and could support both funding currencies JPY and EUR vs. USD .
