Edward Smith: Democrats and Republicans reached a deal yesterday to fund the US government through to the 8th of February. Now, estimates suggest that for every week the US government is shut down, 0.1 percentage points are shaved from annualised GDP growth. Given that two of the three days of the shutdown occurred during a weekend this time, we expect the impact on the economy to be very small indeed. But there is a very real risk that the government shuts down again on the 9th of February and we also know that in March the debt ceiling needs to be renegotiated and that's been frequently co-opted into party political brinkmanship recently.
We estimate that if the government shuts down by a cumulative three to four weeks in 2018, that would fully negate the positive uplifts of GDP provided by the US tax cuts. Now, that's not our base case, but it is a real risk. In order for Democrats to agree to fund the government more than on a stop gap basis, Republicans and Democrats need to reach agreement on immigration reform. Now, that's a highly contentious issue in a very polarised political climate. And unfortunately, both parties believe that the shutdown will hurt the other party more in the upcoming November midterms.
Republicans note that about a fifth of Democrat senators are up for re-election in states that Trump won last time. On the other hand, the Trump shutdown mean seem to be pullulating more on social media than the Schumer Shutdown mean over the weekend.
Now, the good news for investors is that the reaction this time around was fairly sanguine, and a sanguine reaction is typical during these types of events. In the 1995 and 1996 Clinton era shutdown, the S&P 500 continued to outperform global equities, the VIX was unresponsive and dollar didn't budge. In October 2013, the next shutdown, again, there was a little bit more noise, but really you’d struggled to pick it out over the long-term trend. The dollar certainly didn't budge. In the 2013, 2014 and 2015 periods of fraught negotiations over the debt ceiling, again, there really wasn't too much noise at all.
We do expect that another shutdown could further flatten the US yield curve. Now, it steepened again recently, but we think the medium-term trend is for yield curve flattening – that has important implications for sector allocation and overall asset allocation and that's what we will be watching.
