Thursday, October 17, 2013

A deal appears done

There’s good news and bad news this morning.   The good news is a deal is within reach to end the US partial Government shutdown and to raise the debt ceiling.  The bad news is this is only until January 15th for the Budget and February 7th for the debt ceiling, so we get to do it all again real soon.

The direct cost of the shutdown will be reversed quickly as furloughed workers receive back pay and government agencies catch up with postponed spending.  But given the short-term nature of the deal, and the real risk that we see continued short-term deals through 2014, I worry about the impact on business and consumer confidence.  Stronger business and consumer confidence remains an important part of the pick-up in growth we expect to see later this year and into 2014.  A hit to confidence will ultimately prove damaging to economic growth.

Markets have breathed a small sigh of relief, with reaction no doubt tempered by the short-term nature of the deal.  If anything is surprising it’s the fact that Treasuries have rallied.  We read that as the pricing out of default risk.  Even a small risk of a very bad outcome is meaningful in terms of basis points.

Furthermore, I was somewhat dismissive of the FOMC citing the then upcoming fiscal deadlines as a reason not to taper their asset purchase program in September.  As it turns out the Committee was quite prescient.  If ongoing political brinksmanship and fiscal uncertainty is damaging to confidence and economic growth it will have obvious implications for monetary policy.

On a political note, I spent a bit of time working in the New Zealand Parliament so I fancy myself as thinking I know a bit about political strategy.  I continue to struggle to understand the Republicans strategy of running headlong and eyes wide open into a battle they were never going to win.  Given how they play their cards next year, mid-term elections could prove very interesting.  In the absence of a bi-partisan medium-term fiscal strategy (which is never going to happen), the next best thing is a strong President with control of both the House and the Senate.  Watch this space.