Quick Market Update
Keeping the Faith, “Ceiling” an Agreement?
October 16, 2013
Darrell Cronk, CFA®
Regional Chief Investment Officer
Chris Haverland, CFA®
Asset Allocation Strategist
Tracie McMillion, CFA®
Asset Allocation Strategist
In this Quick Market Update:
The U.S. Congress agreed to a deal that reopens the federal government and suspends the debt ceiling.
The agreement includes a framework for budget talks, retroactive pay for furloughed workers, and more stringent income verification for health care exchange subsidies.
The shutdown and debt ceiling uncertainty likely had a modest negative impact on fourth quarter GDP, but any loss in economic momentum should be recouped in the coming quarters.
Investors should maintain adequate liquidity, but also remain fully invested in global assets to mitigate individual country volatility.
U.S. Treasury securities are backed by the full faith and credit of the United States government if held to maturity. Over the past few weeks as Congress has attempted to pass a budget deal and lift the debt ceiling, the creditworthiness of the U.S. has not been in question. Even so, the faith bondholders have in the U.S. government to honor its debts on time has begun to waver, pushing short-term Treasury rates higher. Today’s Congressional agreement restores the faith that those short-term government obligations will be paid on time. However, the agreement represents another temporary fix that pushes fiscal uncertainty into the early months of next year.
The agreement passed by the House and Senate (and likely to be signed into law by President Obama):
Funds the government at its current level ($986 billion) until January 15, 2014.
Suspends the debt ceiling until February 7, 2014, while maintaining the Treasury’s ability to use extraordinary measures1 to meet payments due. The ability for the Treasury to meet payments using such measures pushes out another debt ceiling battle to possibly sometime next summer.
Requires budget negotiation on broad deficit reduction, with a deadline for Congress to reach an agreement by December 13.
Provides retroactive pay for federal workers.
Requires income verification for the Affordable Care Act subsidies (the only health care provision passed during this round).
What are the economic impacts?
The list of business disruptions from the recent government shutdown has been substantial. It has not been just defense contractors and tourists visiting national parks that have lost out. We’ve also seen delays in home sales, delays in small business loans, a stalled IPO market due to a lack of SEC approval, and lack of government data (employment, inflation, etc.), among other downstream impacts. All of these may have had a negative impact on fourth quarter hiring and business spending.
With the shutdown lasting just over two weeks, it has the potential to shave as much as 0.5 percent off fourth quarter gross domestic product (GDP) growth. The good news is that, if history be any guide, the reduction in growth associated with such a shutdown often ends up being delayed consumption. The legislation included back pay for furloughed workers, so we may see some “lost” growth materialize in following quarters.
Although a shorter-term deal was passed, budgeting by continuing resolution has a political cost. It indirectly removes serious fiscal policy initiatives from the conversation. It’s nearly impossible to negotiate complex solutions, such as entitlement reform, tax reform, and a long-term sustainable fiscal path, when the next deadline is just a few weeks away. It also has a measurable economic impact. The uncertainty can undercut consumer confidence just as much as it rattles businesses looking to grow.
Another disadvantage is we are building a bigger “air pocket” in the government data. We have now passed the October employment report survey week, which means the jobs report will not only be delayed for September, but also for October. In addition, even if the government opens at the end of this week or next, it will likely be too late to report the October inflation data (CPI). Both employment and inflation are key indicators the Fed is watching as it considers whether to taper its bond-buying activities that have been providing monetary stimulus to the economy.
What should investors do now?
First of all, it is very difficult, if not impossible, to attempt to time trading activity during this type of political negotiation and short-term market gyrations, so we recommend you stay fully invested. If you are feeling somewhat uncomfortable with the current degree of political risk, we suggest that you speak with your investment advisor to reassure yourself that you have adequate cash/liquidity on hand and the appropriate assets to weather volatility and catastrophic events.
Volatility has been very low by historical measures for much of the year. We continue to believe volatility will rise going forward, and have seen an increase in hedging activity leading up to the government shutdown and debt ceiling negotiations. You may want to consider discussing with your investment advisor how using hedging strategies may help to mitigate risk to your portfolio during volatile times in the market.
As we have recently discussed in our Fixed Income Weekly Outlook, the debt ceiling debate, in particular, has created some dislocation in the bond markets. Because of this, there are a number of steps that you may want to consider, including diversifying your income streams, favoring credit risk over interest rate risk, and asking your investor advisor for a fixed income portfolio diagnostic review to help you better understand where your risks lie.
We also have discussed at considerable length the importance of globalizing portfolios. We believe this value comes not only from return opportunities within the global landscape, but also effective ways to manage risk going forward in portfolios. Yet many U.S. investors continue to exhibit a very large home-country bias. Better global manufacturing data, economic improvements in Europe and Japan, emerging global consumer patterns, and compelling valuations and opportunities in specific emerging markets may be creating opportunities upon which investors can capitalize.
Continuing fiscal struggles around debt and spending will be with us for some time to come, so this will not be the only time this issue will be in front of us. Working with your investment advisor to understand how your portfolio is structured to potentially offset the potential risks associated with these struggles should help provide some peace of mind should we face further budget-related market volatility in the future.
All data for this Quick Market Update was sourced from Bloomberg Finance, LLP, unless otherwise noted.
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1 Since May 19, the U.S. Treasury has been enacting “extraordinary measures” to pay government expenses and hold the national debt at its current limit of $16.7 trillion. That means that under current law, no additional debt may be incurred to fund government expenses. Please see our recent Quick Market Update titled, “Ten Questions about the Government Shutdown and the Debt Ceiling,” for more information.