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‘It Would Push The U.S. Into Recession’: Barclays Weighs In On Debt Ceiling, Shutdown Risk

"A contraction of federal spending of this magnitude, the risk of default, sovereign reputational risk, and negative consequences for confidence and private sector behavior would likely push the economy into a recession if the situation persisted."

As noted earlier, the blame game has already started in Washington with Trump taking to Twitter (where else?) to try and inoculate himself against charges that his ongoing feud with, well, with everyone,  but especially with Mitch McConnell and Paul Ryan, is contributing to the debt ceiling brinksmanship.

First we got this:

Deal

And then, despite the fact that those tweets quite explicitly identify a problem Trump has with “Mitch M”, the President tried to walk it back a few minutes later with this:

If Trump is genuinely interested in not causing a panic, we would gently suggest the following: try to avoid holding nationally televised rallies where you get up in front of thousands of people and threaten to shut down the government unless everyone agrees to build a giant, $25 billion, solar-powered, drug dealer defense wall along the entire border with Mexico. Because that’s the kind of shit that makes people think you’re batshit crazy. But what do we know, right?

Anyway, thanks to the clusterfuck in Washington (and God knows it’s not all Trump’s fault), it’s incumbent upon every desk on Wall Street to put out their own “what if” debt ceiling/government shutdown piece, all of which include references to historical precedent which, unfortunately, there’s plenty of.

Here are a couple of our previous posts on that with commentary from Deutsche and Goldman:

And here is the latest from Barclays, just out:

Yet another fiscal scramble

As we have written previously, we do not incorporate a US federal government shutdown or a failure to increase the debt limit in our baseline US economic and public policy outlooks. While we do not expect either, we recognize that the cumbersome legislative process, a limited number of Congressional working days in September, burgeoning tensions between President Trump and Congressional Republicans, and repeated demands by the president that any budget agreement include border wall funding, among other items, raises the risk of a federal government shutdown or debt ceiling breach that goes against our baseline assumptions. Recent comments by the president have raised the specter of a shutdown, although we still view this outcome with less-than-even probability.  That said, investors should monitor the risk that Trump may reject a GOP appropriations bill if it fails to meet his requirements and whether Congress can (or will) override such a veto.

Government shutdown: Lower effect, higher risk

In addition to lifting the borrowing capacity of the Treasury, Congress needs to complete the FY2018 budget process or pass a continuing resolution by October 1, 2017. If not, the federal government will shut down for the second time in the past four years. While breaching the debt ceiling would be unprecedented, federal government “funding gaps” or “shutdowns” are relatively common. Since 1976, the federal government has experienced 18 funding gaps under the current budget process, although most did not result in a shutdown of operations and a furlough of non-essential employees (Figure 1). Since 1980, following new interpretations of the law, government shutdowns have generally coincided with employee furloughs. This is particularly true during the three most recent lapses in government funding – November 1995, December 1995-January 1996, and September-October 2013 – which are often referred to as true shutdowns. Also, funding gaps do not solely coincide with divided government; five in the late 1970s occurred under one party rule.

Barclays

The border wall – an immigration and national security issue – has evolved to encompass budget and trade issues, especially if the president levies tariffs to fund it. While the administration’s budget requested $2.6bn to begin construction, an internal Department of Homeland Security report estimates that it will cost $21.6bn and take 3.5 years to build.  Congressional Democrats will continue to question the president’s claim that Mexico will pay for the wall and criticize siphoning money from critical domestic programs. In our view, the odds of a shutdown remain relatively low, as we can envision a central scenario whereby Congress gives the Trump administration some increased border funding in exchange for other Congressional priorities, but stops short of explicit funding for the wall.

In the NIPA accounts, a government shutdown is primarily reflected in a decline in real compensation of non-essential employees as a result of reduced hours worked. In the 1995- 96 shutdown, approximately 800,000 of 2.04mn federal civilian (non-postal) workers were forced to take leave without pay, or about 39% of employees.

In the shutdown of 2013, about 850,000 of 2.19mn federal civilian employees were furloughed (a similar 39%). That said, then-Secretary of Defense Gates ordered about 400,000 civilian military employees back to duty after the first week of the shutdown, leaving 21% of federal civilian employees furloughed in weeks 2 and beyond. In addition to compensation costs, the effects of the shutdown are felt primarily in services consumption. A temporary government shutdown at the beginning of Q4 could result in shifts in investment spending from one month to the next and increase the volatility of inventory data, but would be unlikely to disrupt federal consumption of fixed capital and gross investment over the quarter as long as the situation were resolved before year-end. However, services consumption is unlikely to be recovered once halted. BEA estimates for non-defense expenditures unrelated to compensation are based on federal budget data, and a shutdown would be unlikely to alter these accounts unless it persisted past year-end or the BEA modified its procedures on applying annual budget data in its quarterly estimates.

Barclays1

Our analysis suggests that a one-week shutdown in October would reduce real federal government consumption and gross investment 1.5% q/q saar and real GDP growth 0.1pp in Q4 (Figure 2). This is consistent with the CBO’s estimate that the approximately four-week shutdown in 1995-96 reduced growth 0.5pp in Q4 95. Thus, a short federal government shutdown is unlikely to dampen real GDP growth significantly. A longer shutdown, however, could have negative indirect effects on private sector activity.

The debt ceiling: Lower risk, larger effect

The debt ceiling showdowns in 2011, 2013, and 2015, like many before, have led to the use of extraordinary measures to create borrowing room and prolong the date at which the debt ceiling is reached. Extraordinary measures plus the Treasury’s cash balance left about $280bn in operating capacity as of the end of June, but these measures are only temporary; cash balances at the Treasury have gradually moved lower, and borrowing capacity will eventually reach its limit (Figures 3 and 4). Policymakers are running out of time as the September budget and mid-October debt limit deadlines loom. The exact timing of the end of borrowing capacity is uncertain, and the risk of an unforced error is rising.

Barclays3

Failure to raise the debt ceiling would require an immediate cut in spending equal to about 3.5% of GDP (the federal deficit in percent of GDP in 2016 was 3.2%; the average of the most recent four quarters through Q2 17 was 3.8%). Yet even cutbacks of this kind would not rule out a default because previous administrations concluded the Treasury does not have the authority to prioritize interest payments above other obligations. Even if revenues match expenditures in aggregate, federal receipts and payables differ in timing and quantity, and Treasury payment systems are designed to pay bills as they are received. Furthermore, even if the Treasury concluded it could prioritize interest and principal payments, it may still be viewed as a technical default since the government would not be meeting all its obligations.

A contraction of federal spending of this magnitude, the risk of default, sovereign reputational risk, and negative consequences for confidence and private sector behavior would likely push the economy into a recession if the situation persisted.We view the consequences of a debt ceiling breach as extreme and, therefore, unlikely.

Bottom line:

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