Congress is back at work after a five-week recess, and the to-do list for lawmakers is jam-packed with urgent matters that impact the United States economy. Financial markets could be in for a wild ride.
“Investors would do well to brace themselves for a potential twister of volatility in September,” says Leslie Preston, senior economist for TD Economics.
Three major economic issues are on the agenda: avoiding a government shutdown, lifting the debt ceiling and passing a tax reform bill.
Here’s how each could unnerve investors.
Avoiding a government shutdown. Congress must pass a budget by Sept. 30, end of the fiscal year. Lawmakers could pass a temporary spending measure, known as a continuing resolution, to kick the can down the road — but if they fail to do so, the government will shut down on Oct. 1, affecting most non-essential services.
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The last time this happened, in October 2013, the shutdown lasted 16 days and 850,000 federal employees were furloughed. The military continued to operate, and Social Security checks continued to be paid, but national parks and museums were closed to the public, federal small business loans were delayed and other services were reduced or closed.
Overall, Standard & Poor’s estimated the 2013 shutdown took a $24 billion bite out of the U.S. economy, amounting to $1.5 billion a day. Measures of consumer confidence fell. But the market reaction was relatively modest.
Over the course of the 16 days, the Standard & Poor’s 500 stock index fell by more than 2.5 percent, but then recovered its previous value by the time the government reopened. Some investors flocked to government bonds in search of lower-risk assets, driving Treasury prices higher and yields lower.
Credit Suisse research analysts expect a similar market reaction could play out if there’s a shutdown in October, but the pattern may be magnified this time around, hitting stocks harder and reinforcing declines in Treasury yields — mainly because investors could interpret a shutdown as a sign of more discord.
“The last time we had a shutdown with a single party in control was over 40 years ago, during the Carter administration. It will likely be taken as yet another sign of dysfunction, and is likely to lead to a further pricing out of any expectations on the fiscal policy front,” Credit Suisse analysts Praveen Korapaty and Jonathan Cohn say in a note to clients.
Lifting the debt ceiling. Separate from the fiscal 2018 budget, there’s an even more serious crisis looming as government spending nears the debt ceiling.
The debt ceiling limits the government’s ability to issue bonds to pay for spending that Congress already has authorized. The government hit that limit back in March, and since then, the Treasury Department has used emergency borrowing authority, known as “extraordinary measures,” to fund the government’s day-to-day operations. Treasury Secretary Steven Mnuchin has warned Congress that it is “critical” for the debt limit to be extended by Sept. 29, otherwise the government will no longer be able to pay all of its bills. Now, as the government spends on emergency relief for Hurricane Harvey, that date may arrive even earlier, Mnuchin told CNBC.
“This would be equivalent to an individual who has maxed out their credit cards, used all the cash hidden in cookie jars, and whose next paycheck isn’t going to cover their expenses — something has to give,” Preston, the TD economist, says.
The Bipartisan Policy Center estimates that once the Treasury runs out of cash in early October, the government will be unable to meet approximately 23 percent of all obligations in the weeks that follow. The government may have to pay some bills but not others, and it’s unclear which expenditures would be cut first.
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What will this mean for markets?
The bond market is already beginning to show some nerves, with yields rising on short-term Treasury bills as investors require a higher premium to hold the bills that mature in mid-October.
As for stocks, it’s unclear if the market will take this debt ceiling showdown in stride. During the debt ceiling crisis in 2011, the S&P 500 declined 17 percent from July 7 to Aug. 8, and ratings agency Standard & Poor’s downgraded U.S. government debt for the first time in history. It took six months for stocks to fully recover.
But the broader economy has improved and the market reactions to debt ceiling showdowns in 2013 and 2015 were far less dramatic. These more muted responses may reflect that investors have grown to expect an 11th hour deal, Preston says.
That said, this time around, the ratings agency Fitch has warned that if the government stops paying some of its bills, it is very likely to also downgrade U.S. debt. A ratings downgrade could send markets into a tailspin.
Passing tax reform. Stocks rose significantly after the 2016 election, partly because investors and businesses expect Trump to push through economic policies like tax reform. This optimism became more subdued after health care reform failed, and now a big question mark hangs over Trump’s tax reform proposals.
“Expectations of U.S. tax cuts have supported equities, business confidence, and consumer confidence. But if tax cuts are not implemented, business investment and equities could fall — as could GDP,” Jason Schenker, president of Prestige Economics, wrote in a note to clients.
The Trump administration’s proposals for tax reform, released in April, include cutting the corporate tax rate from 35 percent to 15 percent, and lowering taxes on the wealthiest Americans.
“With the economy strong, it’s buying him some time,” says Ryan Detrick, a senior market strategist at LPL Financial. “Still, as we get into the fourth quarter of this year and it looks like tax reform is on life support, the market will probably throw a bit of a fit.”
Could Hurricane Harvey bring Congress together? There’s one wild card that may change the entire legislative agenda in September — Hurricane Harvey.
Some experts point out that showdowns over the budget, the debt ceiling and tax reform may all be postponed as lawmakers find common ground on federal aid for the hurricane. The Federal Emergency Management Agency will soon require more disaster relief funding, and it’s possible lawmakers will combine a Harvey aid package with legislation that temporarily raises the debt limit and extends government spending.
Goldman Sachs’ political economist Alec Phillips thinks a combination bill is most likely.
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“Allowing a partial government shutdown when federal relief efforts are under way would pose greater political risks than under normal circumstances, raising the probability that lawmakers will find a way to resolve disagreements,” he writes in a note to clients.
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3 Ways Congress Could Rattle Markets originally appeared on usnews.com
