US Government Shutdown: Key Implications
The inability of the US House of Representatives and Senate to pass government funding measures for fiscal year 2014, which began October 1, has resulted in the shutdown of the federal government, the first such occurrence since 1996.
While we expect the shutdown to be relatively brief, and while many government functions will proceed uninterrupted, there is the risk that the closure could drag on, weighing significantly on GDP in the fourth quarter and roiling financial markets. Furthermore, the impasse highlights the elevated level of political acrimony that is preventing the US government from carrying out even the most basic functions. Indeed, we see the fight over government funding as an inauspicious precursor to the debate over raising the debt ceiling, another debate that must occur this autumn.
The current shutdown is the result of Republicans in the House of Representatives explicitly tying the funding of the federal government to the defunding of the Affordable Care Act health reform law, also known as 'Obamacare'. This is President Barack Obama's signature piece of domestic legislation. Senate Democrats have refused to defund this law or delay its implementation, and Obama has said he would veto any such measure. Neither side has proven willing to relent, resulting in the current shutdown. While the government remains closed, many services will not be provided and federal government office buildings will be shut.
The most recent example of a federal government shutdown, which lasted for 21 days in late 1995 and early 1996, proved politically damaging to Congressional Republicans, who were perceived as irresponsible and eventually relented. We expect the latest shutdown will prove to be relatively short, and believe that this time round the political cost to Republicans could also bring them to the negotiating table. However, we readily admit that it is hard to anticipate at the outset how this shutdown will be perceived, or which side will feel more pressure to give ground.
Market And Economic Impact Modest… For Now
Global financial markets did not show an immediate negative response, with equity markets mixed in Europe and Asia in the first day of trading after the shutdown became official. The Dow Jones Industrial Average and the S&P 500 Index were relatively unchanged as the shutdown went into effect on October 1. US Treasuries sold off on September 30 and were down in early trading on October 1, suggesting no flight to safety in the first few hours after the shutdown. While we have not yet seen a major market correction, we expect this could change rapidly if Congress fails to reach agreement in the near term.
Additionally, the economic cost of the shutdown could become quite significant if Congress does not pass funding and allow for the federal government to resume operations fairly quickly. The US government employs 2.1mn civilians, the vast majority of whom will receive no pay during a shutdown. If allowed to persist for even a week or two, a shutdown would weigh heavily on regional and local economies that are exposed to federal employment – particularly the Washington, DC, metro area.
Not The First Time
Since the mid-1970s, Congress and the President have failed 17 times to enact spending measures before existing funding ran out, and since 1980 funding gaps have required affected government agencies to cease operations until new funding is allocated. Exemptions are made for those agencies and employees that are responsible for protecting life or property, meaning that a substantial number of federal employees will remain on the job without pay, but many more will be furloughed.
Shutdown Only Affects Part Of Budget
The funding measure that Congress has failed to produce is classified as 'discretionary' spending, authority over which must be passed every year, traditionally through 12 appropriations bills, that directs the government to spend money on various activities that Congress has already authorised. However, this spending, while quite significant at US$1.3trn, represents just over one third of federal government spending, as the majority of total federal outlays comes from 'mandatory' spending, such as Social Security and Medicare, among other entitlement programmes. These programmes do not require annual appropriations and will continue to distribute funds to recipients.
More High-Risk Politics Ahead
The October 1 funding deadline was not the only date this autumn that will see contentious partisan debates that threaten to disrupt markets and interrupt the normal operations of the US government. The US government will hit the statutory 'debt ceiling' by mid-October, after which it will no longer be able to borrow money to roll over its debt or meet existing payment obligations, thus triggering a default. The willingness of both Republicans and Democrats to allow a government shutdown just weeks before the debt ceiling fight does not bode well for this deadline, although our core view remains that the US will not default on the debt. Indeed, there is some possibility that the current spending fight, largely being waged by hard-line conservatives within the House Republican caucus, could provide political cover to find a compromise on the debt ceiling and avoid defaulting on US debt.
Additionally, there is a significant chance that the fight over discretionary spending could repeat itself before year-end. The funding measures that the House and Senate passed in recent days, while not finding common ground on funding, were both short-term only. The House bill would have allowed government operations until December 15, the Senate until November 15. As we believe that one of these two measures is likely to form the core of an eventual compromise, we believe it is almost certain that Congress will engage in a budget debate again before the year is out.