Today’s commentary
Summary: I expect the debt ceiling impasse to be overcome today as a result of a Senate-brokered deal. With this manufactured crisis out of the way, we can concentrate on earnings and on the economy. While US growth is on track, I expect earnings growth to be weak and growth to ebb from this point in the cycle forward.
The Politics
As I wrote last night, US Senate leaders Mitch McConnell and Harry Reid have brokered a deal that looks to have buy in to be able to win approval in both the Senate and the House of Representatives. Most commentators expect this legislation to pass and be signed by President Obama later today. With default off the table, the US economy can regain its normal footing and the news flow will turn to other subjects.
The brokered deal does almost nothing for Republican Tea Party activists regarding spending cuts or changes to the Affordable Care Act. What we are likely to see is a push of the debt ceiling into February and a means test for ACA subsidies as I wrote last night. Overall then, this is a loss for the Tea Party both in terms of legislative objectives and in terms of the political outlook. It was clear from the start that this ill-conceived gambit was not going to work legislatively. And I have said that it will end up costing the Republican Party, which I still believe is true.
For activists like Justin Amash of Michigan, who has garnered a high profile and bipartisan acclaim due to his opposition to the NSA spying program, participation in the debt default brinkmanship is a black eye that will permanently tarnish their bona fides as reasonable governing policy makers. Thirty-two Republicans are considered to be ringleaders in the House uprising. Previously I noted that most of these individuals have made a logical calculus in promoting brinkmanship due to the demographics of their districts and the fear of being defeated in 2014 by more ideologically-pure primary opposition. Nonetheless, their will be a price to pay for the Republican Party as a whole. Michele Bachmann is already bowing out of Congress and I expect others in this group to follow. The question is whether their districts flip. More problematic for Republicans are the moderate Republican districts where continued brinkmanship will lead to a revolt of swing independent voters.
For the President, this turns him from a lame duck tarnished by missteps on Syria, the NSA and the Fed nomination process into a formidable political opponent for a while longer. That is a gift to the Democratic Party given by the house Republicans.
The Economy
The U.S. recently gave up its role as fastest growing economy in the developed world to the UK. I believe this is significant both in the context of the growth subtracted by the government shutdown and in terms of the overall business cycle. First, if the shutdown ends soon, I estimate we will see no more than a 0.5% reduction in growth. Overall, the reduction in compensation was perhaps $300-400 million per day. But given the fiscal multiplier from diving consumer sentiment and a declining standard of living, we should expect that number to be compounded to get us to a 0.5% growth reduction. That means that while he U.S. economy could grow as much as 2.0% in Q4, I believe we will probably see annualized GDP growth for Q4 come in with a 1-handle.
Irrespective, recent economic numbers suggest US GDP growth has peaked. The recent low jobless claims figures may have been subject to some data anomalies. Nonetheless, the figures are much better than a year ago and point to both a peak in jobless claim reductions and a trough in seasonally-adjusted jobless claims. I expect jobless claims data to become less favourable moving forward, translating into a greater headwind to the associated wage income. Unless consumers accumulate debt or we see some stellar increases in hourly earnings figures in the coming employment situation summaries, this headwind will translate into slower GDP growth.
On the earnings front, we are getting into earnings season now and we will soon see how companies are faring. Given the macro data, I would expect to see slower earnings growth or even contracting earnings. First, jobs data do not suggest that companies are increasing earnings through excess hiring restraint. Second, given the stable level of household savings level, by national accounting identity, we should expect the reduction in net deficits at the government level to lead to concomitant changes in corporate earnings or the current account. The US government has gone from a deficit of 10% of GDP to an expected deficit in fiscal year 2014 of less than 4%. Those changes have to reflected in the domestic or external sectors in equal measure. And I therefore expect earnings to fall.
Brief concluding thought
The US economy has outlasted my 2009 prediction that the US would suffer a recessionary relapse from excessive deficit reduction. We have seen a net reduction of 6% of GDP in the deficit, something we haven’t seen in sixty years. And the US has beaten back a sequester and multiple debt ceiling scares. And the economy is still growing That is a remarkable run. I don’t like being wrong, but my thesis regarding the recession will probably be proved wrong if the US Congress stops the shutdown later today and that’s a good thing. The question then becomes what happens in the next cyclical downturn, with interest rates at zero percent and a Fed balance sheet bloated by quantitative easing. The recovery has gone a long way in removing some of the debt problems in the private sector. But households are still heavily indebted and there has been no wage growth in the US. The next recession will be interesting in the context of still ongoing battles over federal deficits. If it happens before those deficits are brought down further, policy space will be very limited on both the fiscal and monetary side. And that would bring the full weight of household sector debt deflation down to bear on households without significant policy stimulus.