Light At The End Of The Government Shutdown Tunnel

The Deal

The deal that’s been cut, largely, mirrors that which was reported by a host of media outlets towards the start of last week, with negotiations having progressed in earnest since then.

Put simply, the bipartisan agreement would pave the way for a ‘3+1’ legislative package – namely, a continuing resolution to provide funding to federal agencies until 30th January, along with three ‘mini-bus’ bills that would fund the Department of Agriculture, Department of Veterans Affairs, and Congressional operations for the entirety of the current fiscal year. In return for their votes, Democrats have obtained a promise from the Trump Admin to rehire federal workers that were fired at the start of the shutdown last month, as well as the promise of a floor vote in the Senate on extending expiring Obamacare tax credits.

The Vote

That deal has already cleared an important procedural milestone in the Senate, with the upper house voting 60-40 in favour of advancing a stopgap funding bill that was passed in the house many weeks ago. This bill, for simplicity’s sake, is being used as a vehicle for the aforementioned deal, with that framework now to be amended into the text of the aforementioned stopgap measure.

While that milestone is important, there remain many more hurdles that must be cleared, before federal funding can be restored. The Senate, firstly, must move to a final vote on the spending package which, while possible as soon as today, could be held up by any single Senator refusing to yield back time on the floor. In any case, once the Senate have signed off on the package, the House must also give it the nod, which could also be anything but a quick feat, given that Representatives remain out of town, as they have been since mid-September, and with numerous air travel issues (resulting from the shutdown) complicating their return to DC.

Impact

Assuming that, eventually, the above package receives the requisite number of votes in both chambers of Congress, focus among market participants will turn to the impact of the shutdown, both that which has already been wrought, and what may now lie ahead.

In terms of the impact already seen, it has typically been the ‘rule of thumb’ that every week of a shutdown subtracts around 0.1pp from US GDP growth in the quarter in question, with the sum total of that lost output then recouped the following month. Arguably, the economic hit from the current shutdown, in the last week or so at least, could be somewhat larger, given factors like the mounting number of air traffic delays.

As for other areas of the economy, while consumer confidence has taken a substantial hit amid the impasse in Washington DC, with the UMich index falling close to record lows per the preliminary November reading, this has demonstrated little by way of statistically significant correlation with consumer spending for much of the cycle. Furthermore, with the aforementioned agreement including a commitment to full back pay for laid off federal workers, another potential downside consumption risk has been removed.

In terms of the labour market, it’s clear that the October jobs report (more on which below) is going to be an incredibly messy one. Those laid-off federal workers alone, amounting to around 700k, would probably push the headline U-3 unemployment rate to around 4.8%, before one considers any potential related job losses that may have also stemmed from a lack of federal funding. This could also skew the November jobs report as well, depending on the exact timing of the government re-opening, with this week being the reference week for that report. That said, in a similar manner to how lost economic output will be recouped, one would expect the majority of these workers to return to payrolls in short order, if not immediately, once the shutdown comes to an end.

Data Interruptions To Continue

Speaking of economic data, even though the government may soon re-open, that does not mean that all of those delayed economic releases will magically be released all of a sudden.

In terms of employment data, the BLS are likely to be able to release the September jobs report relatively rapidly (it took just 3 working days after the 2013 shutdown ended), with the data having already been collected, and compiled. The October jobs report, though, is a different kettle of fish, with no data collection having taken place amid the shutdown meaning that, while the BLS will now send out the usual surveys upon re-opening, they will be asking the population to reflect on employment conditions around 4 weeks ago, naturally leading to concern over how accurate the data is likely to be. The same applies to the November jobs report, data for which is due to be collected this week, and which may also be delayed depending on when funding is restored.

The impact of the shutdown on other economic releases is likely to be more significant, and longer-lasting. On inflation, for instance, data for the CPI and PPI reports, and by extension the PCE report, is collected throughout the entirety of the month, with some price data for CPI still collected by physically visiting various outlets. While the BLS could estimate the data that was missing, it seems highly unlikely that the agency would want to go down that path. This raises the risk that the BLS, instead, decide that they are unable to publish CPI data for October, with there also being the potential for the November report never to see the light of day, depending on exactly when the government re-opens.

Of course, we await confirmation from the agencies in question as to precise data collection, and publication, schedules as and when funding is restored. However, it seems highly likely that interruptions to the usual data docket will persist into the early part of next year, meaning that policymakers and market participants alike are likely to be ‘flying blind’ for some time to come.

Looking Ahead

Naturally, markets have reacted positively to news that the government may soon re-open, with equity futures gaining ground, the dollar a touch firmer, and Treasuries softer across the curve.

This, while potentially an obvious reaction, does make considerable sense, given that restoration of funding would remove a significant growth headwind, but also a huge chunk of uncertainty which had increasingly been clouding the outlook, allowing participants to re-focus on what remains a solid bull case of the underlying economy remaining robust, earnings growth proving resilient, the monetary backdrop continuing to loosen, and a calmer tone being taken on trade.

As and when the government re-opens, however, the assumptions underpinning that bull case will now come under the microscope. While we have all, using various private sector data as proxies, operated on the assumption that little has changed with the economy over the last six weeks or so, we may finally soon have some data to prove, or disprove, that theory. There is also the question of the monetary policy backdrop where my base case remains that the Fed will deliver another 25bp cut at the December meeting, despite Chair Powell noting that such a decision is ‘far form’ a foregone conclusion. Should incoming labour data point to the jobs market continuing to stagnate, as is likely, such a cut is likely to become much more of a ‘done deal’, opening the door to a potential dovish repricing of rate expectations, with the USD OIS curve implying just a 2-in-3 chance of another cut by year-end.