US federal agencies have begun to close as part of the partial US government shutdown. The deadline of midnight on 30 September, when the 2013 fiscal year ended, passed without Republicans and Democrats bridging their differences over the budget. Conservatives in the Republican Party refused to pass a short-term budget unless it included a delay to President Obama's Affordable Health Act (commonly called 'Obamacare'). This repeated insistence on tying an extension of the budget to delays in Obamacare was rejected by Democrats in the Senate. As a result, government ground to a halt, with non-essential services being shut down to ensure essential services can be funded. About 800,000 federal employees are being placed on unpaid leave until a resolution to the impasse can be found.
Risk markets rallied
overnight as investors were buoyed by expectations that the shutdown will only
be temporary, as well as a better-than-expected Institute for Supply Management
(ISM) survey result on the state of US manufacturing. In addition, equity markets
were supported by the fact that the US Federal Reserve delayed tapering its
quantitative easing (QE) programme in September and due to expectations that
the current debacle in Washington may further delay tapering.
Is the market right
and we will see no damage to equity markets and to the state of the US economy?
The answer very much depends on how long the shutdown will go on for and
to what degree it damages confidence in a stage when the US economic recovery
is gaining some traction.
Most market commentators
are viewing the shutdown as temporary, believing the Republicans in the House
of Representatives will back down and pass a 'clean' Bill which the
Democratic-controlled Senate will pass. A clean Bill is one which is
unencumbered by any clause which delays or adjusts 'Obamacare'. However,
the Republicans despise this health care law, particularly the extreme
right-wing Tea Party which is a powerful faction.
The Republicans did
blink at the end of 2012 when the deadline was approaching for the 'fiscal
cliff' - a set of spending programs and tax cuts expiring at year-end.
Despite a stand-off between the Obama Administration and the House of
Representatives, the matter was resolved as both sides saw that their
constituencies would lose out and that it would likely send the
still-recovering economy back into recession if triggered all at once. However,
that doesn't necessarily mean that they will resolve it easily this time.
Districts voting for Congressmen in the House of Representatives don't necessarily
reflect a diverse population, which is why the House often seems to be more
extremist than the Senate. Clearly, Congressmen represent their constituents
and vote reflecting their concerns so a government shutdown won't necessarily
force the extremists to roll over.
The other factor to
consider, and actually more concerning for markets, is the upcoming 17 October
deadline for Congress to lift the debt ceiling. If there is no agreement on
lifting the ceiling, it would trigger a technical default on US debt and could
engender a global crisis. However, in our view, the House is unlikely to use
the debt ceiling as a tool to hurt the Obama Administration as it could
severely impact the creditworthiness of the US.
It goes without
saying that equity markets' performance will depend on how the politics play
out, but it may take a bit longer than the market thinks. If the shutdown
is longer than a few days, the US Federal Reserve will further delay tapering
and this should be supportive for the bond market. We could see US
10-year Treasury yields hit 2.50%, down from 3.00% just a month ago (they are
currently sitting at around 2.66%).
This
political uncertainty in the US and the fact the Federal Reserve's tapering of
QE could be delayed is likely to be marginally positive for the Australian
dollar. This should be supportive for Australian rates despite the unwinding of
the Reserve Bank of Australia's (RBA's) easing bias. A stronger dollar will put
a greater strain on the RBA and means that further rate cuts cannot be ruled
out, although this is not our base case. In our view, we have likely reached
the end of this easing cycle and expect rates to remain at 2.50% for some time.
Indices:
The
Australian All Ordinaries Index has moved down decreasing by -1.4%
since closing last Friday to end of trade Wednesday.
The
rest of the world as measured by the MSCI index decreased -1.2%
in A$ from closing last Friday to end of trade Wednesday.
Have
a great weekend,
The Team at IPS
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