Thelma and Louise or Rebel without a Cause? A Whipsaw Week in Washington

Wardwell’s Weekly Market Report

Observations on the Capital Markets – Week Ended September 27, 2013

  • Movies to match the political fight in Congress
  • Not passing a budget today is not hitting an immediate fiscal cliff
  • What gets cut if there’s no resolution?
  • Last Week’s Job Market and Consumer News, Some Good

Movies To Match The Political Fight In Congress

In the past, I’ve compared the budget and debt ceiling fights at putting the economy at risk of a “Thelma and Louise” moment—the Republicans and Democrats might drive the economy over a fiscal cliff. I’ve decided that that’s not the best movie allusion. We have to go back farther, to “Rebel Without a Cause” where James Dean and Sal Mineo raced their cars toward a cliff: If you jump out first, you’re a loser and a coward. If you don’t jump out in time, you’re dead.

At this point, both the Senate and House have the opportunity to vote for a bill to continue funding the government and avert a shutdown:

  • The bill in the Senate (sent to it by the House) would trim select aspects of Obamacare. The Senate leadership has said they will bring it to a vote, expecting it to fail.
    • The President has said he’ll veto it if the Senate passes it.
    • The Senate can amend the bill, pass an amended bill, and send it to the House, giving the House another chance.
  • The bill currently in the House (sent to it by the Senate) wouldn’t trim Obamacare.
    • If Speaker of the House Boehner brings it up for a “clean” (no amendments) vote, it might pass…with the ‘yes’ votes from moderate Republicans and Democrats overriding opposition from the Tea Party wing of the Republicans. In that scenario, it’s also likely that the Speaker would immediately be voted out of office (leader of the House Republicans) and replaced by a Speaker who is more “Tea Party aligned” than Boehner…thus setting up an even more adversarial debt ceiling fight.
    • The House can amend the bill, pass an amended bill, and send it to the Senate, giving the Senate another chance.

Both the House and Senate also have the opportunity to further refine their positions, hopefully negotiating toward a bill that can pass both houses and be sent to the President.

  • They can either do this publicly (by lobbing bills back and forth as they are doing) or by going “into committee” (essentially a closed-door negotiation).
  • The President retains the right to veto any bill Congress sends to him. (Congress could override the veto, but it’s highly unlikely…an override requires 2/3 of the votes in each house)

Because either party, and either House, has the opportunity to send a bill to the President, assigning “blame” is a purely political activity. Neither party is blameless or innocent. It’s a game of “chicken” . . . the loser in the political game is the party that blinks first. If neither blinks, the government shuts down.

Not Passing a Budget Today is Not Hitting An Immediate Fiscal Cliff

  • This is just like the year-end fiscal cliff: the countdown clock is a media invention. A deal which is retroactive to 9/30 can be struck after midnight tonight, in a few days or in a few weeks.
  • If no deal is done by midnight, the government has the latitude to continue funding everything on the “good faith” assumption that a deal will be struck that is retroactive to September 30.
  • At some point, if that “good faith” assumption looks untenable, a shutdown will commence…but it will be relatively orderly, not abrupt and across-the-board.

What Gets Cut if There’s No Resolution?

  • “Essential service” employees like air traffic controllers and postal employees won’t be furloughed. Interest on Treasuries and entitlement programs will continue to be fully funded.
  • Uniformed military will still be paid, but civilian contractors are likely to be furloughed and procurement delayed.
  • National parks and other non-mission-critical areas like the EPA will see the most drastic cutbacks.

What’s next?

  • The budget is just a preliminary bout: the debt ceiling awaits.
  • The debt ceiling would/will be much more of a fiscal cliff than the budget fight. As noted above, the budget isn’t going to abruptly hammer the economy. Hitting the debt ceiling, on the other hand, would force the government to immediately reduce its outlays by something like 4% of GDP (the size of the deficit). That would probably be a large enough and abrupt enough hit to the economy to drive GDP growth into negative territory (risk/cause a recession).
  • A default on the federal debt shouldn’t/wouldn’t necessarily occur immediately after the debt ceiling cliff—the government can prioritize payments—but it would worsen the problem.
  • The Tea Party wing (rightly or wrongly) sees the budget and debt ceiling votes as the last/best places to stop the roll-out of Obamacare…and—if they’re not bluffing—they’re committed. Without commenting on the merits of Obamacare or the tactics of the Tea Party, I’d judge that the next few weeks will be “interesting” and somewhat scary.
  • If Congress and the President manage to avoid driving the U.S. economy off a cliff (pick your preferred movie reference), the underlying economy looks fine: the risk of a normal business cycle recession appears to be very low. Labor markets continue to improve, personal and business earnings continue to rise, consumer and business balance sheets are strong, business inventories are low, and there are few visible bottlenecks or inflation pressures.

Last Week’s Job Market and Consumer News, Some Good

The job market saw more good news with the 4-week moving unemployment average down to 308k its lowest reading since June 2007. Consumer spending power continued to rise as did household wealth, which increased 1.8% quarter over quarter in the second quarter, reaching a record-high $74.8 trillion as house and equity prices rose. This is in fact what quantitative easing (QE) was seeking to achieve: higher wealth should boost spending (economic activity)—pure “trickle-down” economics. Nevertheless, caution remains the watchword.

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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