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US debt debacle: The show’s over – for now

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Schroders Chief Economist, Keith Wade (pictured), comments on the US Congress decision to approve federal spending and lift the debt ceiling after 16 days of government shutdown, and the impact that this could have on markets…

After 16 days of government shutdown, Congress has approved a bill to fund federal spending and lift the debt ceiling. The measures agreed will keep federal government running until 15th January and lift the debt ceiling until 7th February. There are also instructions for budget negotiations to conclude by 13th December. The risk of default by the "greatest” nation (borrower) on earth has been avoided and furloughed public employees can get back to work. Winston Churchill's maxim that the Americans will always do the right thing, but only after having exhausted all the alternatives, appears to have held once more.

The shutdown will have depressed US growth as although workers will receive back pay and contractors can get back to work, there will be many who have lost out on spending that will not return.  According to Bloomberg, S&P reckon it has cost the US economy $24bn or about 0.6% off annualised GDP for the fourth quarter. This may be on the high side, but the real difficulty is gauging the impact on spending decisions which require some certainty over the future, such as capital spending or residential investment. There is evidence that these have been affected and the news that we might go through the same thing in the New Year is hardly going to fill investors and businesses with confidence such that they go out and spend.

So can we expect a repeat of the wrangling and brinkmanship in less than 3 months’ time? There are grounds for expecting a better result. First, the Republicans are putting a brave face on the outcome, but they have suffered in the opinion polls and may be less willing to take a stand. Tension may increase if the Democrats push hard to reduce the impact of the next round of the sequester (spending cuts), but both sides will have an eye on the mid-term elections due in November 2014 and might be expected to try and win back some public trust in Washington. Second, there is more scope for the Treasury to extend the debt ceiling, perhaps as far as the summer at which point campaigning would be well underway and both sides would like the debt ceiling can to have been kicked.

From a market perspective the main impact is that the Fed will need longer to assess the state of the economy. Economic data has been delayed, distorted and depressed by the shutdown and it will not be until early next year that we can get a clear picture of the fourth quarter. The risk of another political stand off will also weigh on Federal Reserve deliberations. As a result we would not expect tapering to begin until March next year with the possibility it will be delayed until June to accompany a press conference from new chair Janet Yellen.

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