The ongoing dysfunction in Washington D.C. reached a fever pitch this week, as the failure of lawmakers to agree on a bill to fund the Federal Government resulted in the President ordering its first shutdown since 1995. The inability of Congress to effectively legislate has led to the furlough of more than 800,000 Federal workers, and a shuttering of all non-essential services. Although equity markets around the world have remained relatively sanguine about the current state of affairs inside the beltway, the looming deadline to raise the debt ceiling, which the Treasury Department has declared to be no later than October 17, has heightened the stakes of the current impasse immeasurably, as a breach of this borrowing limit would have dire consequences not just for the United States, but for the global economy in aggregate. It is the presence of this possibility that provides us with cautious optimism that a resolution might be forthcoming; as our belief is that the closure of the government and the subsequent pressure being applied by the electorate to end the stalemate has pulled forward the debt ceiling debate, which may result in a bargain that addresses both issues. However, we intend to remain hyper-vigilant about the progress of these negotiations as we fully recognize the severity of the impact of a failure to honor our nation’s debts.
The current standoff has resulted from a multiplicity of factors, chief amongst which is a fundamental ideological difference between the parties over the Affordable Care Act, popularly known as “Obamacare”, which went into effect this week. It is the vehemence of both sides in this debate combined with the extreme partisanship in the Capital that have made this situation particularly perilous. Despite assertions to the contrary, the shuttering of the government comes at an exorbitant cost. According to the New York Times, “ the research firm IHS Inc. estimates that the shutdown will cost the country $300 million a day in lost economic output…Moody’s Analytics estimated that a shutdown of three or four weeks would cut 1.4 percentage points from fourth-quarter economic growth and raise the unemployment rate.” With consensus estimates for GDP currently at only 2.5% per annum, the present state of affairs, if not soon rectified will take an ever increasing toll on the nation’s economy.
Since 1970 there have been a total of 18 shutdowns of the Federal Government, including this most recent closure. Although each situation was unique, what is common amongst them is that investors have, on average, approached them with relatively little trepidation. According to Ned Davis Research, “during the six shutdowns that lasted more than five trading days, the S&P fell a median 1.7%.”In fact, optimism in the marketplace has tended to follow these periods of uncertainty. Bloomberg News writes that, “the S&P has risen 11 percent on average in the 12 months following past government shutdowns, according to data compiled by Bloomberg on instances since 1976. That compares with an average return of 9 percent over 12 months.”
There is one glaring difference between this year’s shuttering of the government and those of recent history, and that is the presence of the debt ceiling. According to the New York Times, “the Treasury said last week that Congress had until Oct. 17 to raise the limit on how much the federal government could borrow or risk leaving the country on the precipice of default.” Though we can look to the past as a guide to use to try and gauge the impact of a government shutdown, there is no way to accurately predict the effect of a failure of the United States government to fulfill its obligations, as this would be unprecedented. The need for Congress to raise the debt ceiling cannot be overstated, as the very sanctity of U.S. sovereign obligations depends upon it. The importance of this faith to the global economy was captured by Nobel Prize winning economist, Paul Krugman, “Financial markets have long treated U.S. bonds as the ultimate safe asset; the assumption that America will always honor its debts is the bedrock on which the world financial system rests.”