InvestmentsOct 9 2013

US political stalemate may stymie recovery

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Mr Cole, investment director on the company’s global multi-asset group, said although a last-minute deal to approve a budget is the “most likely outcome”, a small reduction in US GDP for the quarter was “to be expected”.

He added that politicians from either side of the political divide would likely have to give ground, meaning a greater chance of fiscal tightening in 2014.

The US government had to enact a partial shutdown last week, which meant it put non-essential staff on unpaid leave until a budget for the 2014 fiscal year could be agreed upon.

The situation has become even more serious because the country has to agree on whether to extend the debt ceiling beyond its $16.7trn (£10.4trn) limit on October 17.

If politicians fail to reach an agreement, Mr Cole said US president Barack Obama would have to choose which federal bills to prioritise to “avert complete paralysis”.

“As a result, additional fiscal tightening is likely in 2014 as the federal government looks to rein in expenditure,” he said.

“Such a move may well mean the Federal Reserve will look to keep monetary policy relatively stimulative, maintaining its asset purchase programme at or near the current rate of $85bn per month.

“In other words, it might be longer than many market commentators think before the Federal Reserve begins to reduce its programme of bond purchases in earnest.”

Mr Cole said US equities had been “somewhat weaker” on the day before the shutdown took effect, with global equities “mirroring this”.

“The US dollar has also dropped back, along with Treasuries, as investors shy away from the US as a result of the current uncertainty,” he said.

“The bigger concern is that there will be no progress on a deal to raise the debt ceiling.”

Mr Cole added that he had positioned his multi-asset funds for the likelihood of political brinkmanship in the US.

“From where we stand, the shutdown was a long-expected event, given the pre-existing tensions between the two parties. [As a consequence] we positioned the multi-asset portfolios we manage in advance of the event,” he said.

Elsewhere, David Harris, head of US multi-sector fixed income at Schroders, agreed the debt ceiling debate had “potentially more important consequences”.

“Near-term implications of the government spending stalemate are mainly economic,” he said.

“A shutdown for less than a week will have a minimal impact on Q4 growth and the market consensus is that there are no lasting effects aside from some lost wages and perhaps weakened confidence.

“[But] the longer the US government shutdown goes on, the larger the economic impact will be.

“Beyond two weeks the impact would begin to accelerate, as most wages lost would not be made back and we would begin to see the secondary effects of productivity declines and business decisions put on hold.”

He added that the shutdown in 1995 lasted 21 days and estimates suggest it subtracted roughly 1 per cent from GDP.

Bill O’Neill, chief investment strategist at UBS Wealth Management UK, said the longer the deadlock went on for the more difficult it could be to agree on extending the debt ceiling.

He added there had been 17 US government shutdowns since 1976, with the most recent being in 1995/96 under President Bill Clinton but the risk with the latest one was that the two sides of the political divide were “very far apart”.

“There is not really a process of negotiation being entered into,” he said.

Adding: “The risk this time is of an extended shutdown which then mixes with the debt ceiling debate. The big thing to watch for will be the constituency reaction.”

Mr O’Neill said the US government would be able to use its cash reserves if it failed to agree on the debt ceiling.

“There would be about $50bn which could get them through to early November but it would become difficult,” he said. “It could get to the possibility that something very dramatic happens like the president enacting emergency powers to ensure the country’s debt is serviced.”

Scott Glasser, co-chief investment officer at ClearBridge Investments, agreed a strung-out affair could impact economic growth.

“An ongoing impasse lasting a couple of weeks, however, would begin to reduce fourth-quarter GDP. We expect Congress, at a minimum, will work out a short-term solution over the coming weeks.”

Bryn Jones, manager of the Rathbones Ethical Bond and Strategic Bond funds, said if the shutdown debate led to a “full-blown bundle” about the nation’s debt ceiling, the market would become more volatile.

“That would mean the US could default on its debt, something the rating agencies are likely to take interest in over the next few weeks,” he said.

“No one benefits from this. Amid one of the most ridiculous pieces of politics in US history, GDP could take a hit in what is a modest recovery.”

What happened?

A shutdown of the US government is when all departments considered “non-essential” are closed and the staff placed on unpaid leave.

Non-essential covers such jobs as park rangers, but also affects a large number of Pentagon employees, while staff operating important services such as social security welfare payments stay at their desks.

There are varying reports about who exactly has been affected by the shutdown of the US government. Hundreds of thousands of staff have been put on unpaid leave for the duration of the shutdown, but the numbers quoted vary from roughly 700,000 to more than a million people.

The shutdown does not directly affect private business or markets, but US consultancy firm IHS said the move could cost the country at least $300m a day, primarily through reduced consumer spending from unpaid staff.

Why did it happen?

The shutdown occurred because the US House of Representatives and the US Senate failed to agree a budget for 2014 before the deadline at midnight on September 30.

The main sticking point on the negotiations was the Affordable Care Act, dubbed ‘Obamacare’, which was signed into law by President Obama in 2010.

One of the main aims of the scheme – to allow access to health insurance for millions of uninsured Americans – is being rolled out in the coming months.

The Republicans oppose the programme so the House has refused to pass a budget that includes funding for Obamacare, while the Democrat-led Senate stands behind its flagship law.

What next?

The shutdown is just a prelude to the debate about raising the country’s debt ceiling, which is the limit that the government is allowed to borrow.

An agreement between Congress and the White House on raising the $16.7trn (£10.3trn) borrowing limit has been put off since negotiations around the ‘fiscal cliff’ of spending cuts and tax rises broke down at the end of 2012, and temporary measures have been put in place to allow continued borrowing.

But those measures will expire by October 17 and if no agreement can be reached, the US will not be able to pay the coupon on its debts, sending it into a default that experts say would be disastrous for global markets.