Well, Congress did it again. It managed to create a sense that the United States might actually default on its debt before delivering yet another eleventh-hour deal to make sure that wouldn't happen.
The stock market never really bought into the bad act - or perhaps we should say sold into it. Sure, there were a few bumps along the way, but with all of the dire warnings about what would happen if Congress didn't strike a deal, the S&P 500 was down just 1.8% from its all-time high when it became apparent a deal would get done before the nation's borrowing capacity ran dry on October 17.
It was some deal, too, because it managed to accomplish everything and nothing all at once. At the same time, it left ample reason for the stock market to think the FOMC won't be making a tapering announcement until sometime in 2014 at the earliest.
One source after another, including us, will refer to the deal Congress struck as kicking the can down the road. It is easy to understand why. The agreement that was struck calls for:
- Providing funding for the government through January 15
- Raising the debt limit to meet the nation's borrowing needs through February 7 (extraordinary measures could take it to late March)
- Maintaining sequestration
In other words, the deal is just a short-term fix that moved the needle on the deadlines but did nothing to address matters of long-term fiscal sustainability.
The thinking is that the agreement will provide some breathing room for Congress and President Obama to engage in some serious budget negotiations that result in a grand bargain both sides can be happy about (apparently, the 25 months they had since the last debt ceiling debacle just weren't enough).
Well, let the negotiations begin.
We'll believe in the grand bargain when we see it, but it's not as if anything has changed with the latest agreement. The Republican leadership still doesn't like Obamacare or the thought of tax increases to cut the deficit. Meanwhile, the Democratic leadership continues to stand behind the president's signature piece of legislation and isn't keen on achieving deficit reduction without revenue increases.
The partisan divide still runs deep, evidenced by the fact that every 'no' vote in the House and Senate on the latest agreement was cast by Republicans. The divide won't be closed easily either with the midterm elections that much closer in January than they are today.
From a Can to An Oil Drum
The past is the past. It can't be undone, except in politics. Laws get repealed altogether or new laws get written that supplant past laws.
There is general agreement that the sequestration was bad policy. It could potentially be undone or re-worked in upcoming negotiations. We don't know.
Objectively, there is no denying that economic growth (albeit sluggish) and tighter spending constraints have been successful in cutting the deficit as a percentage of GDP. The 2013 Long-Term Budget Outlook prepared by the non-partisan Congressional Budget Office makes that point clear.
"The economy's gradual recovery from the 2007-2009 recession, the waning budgetary effects of polices enacted in response to the weak economy, and other changes to tax and spending policies have caused the deficit to shrink this year to its smallest size since 2008: roughly 4% of GDP, compared with a peak of almost 10% in 2009. If current laws governing taxes and spending were generally unchanged - an assumption that underlies CBO's 10-year baseline budget projections - the deficit would continue to drop over the next few years, falling to 2% of GDP by 2015. As a result, by 2018, federal debt held by the public would decline to 68% of GDP (from about 73% now)."
There is more to the CBO view, however. The CBO also points out that budget deficits would gradually rise again due to higher interest costs and growing spending for Social Security and the government's major health care programs. It goes on to warn that:
"By 2038, the deficit would be 6 1/2% of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100% of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable."
The overarching point is that if Congress and the president want to put the country on a path to long-term fiscal sustainability, there needs to be entitlement reform and tax reform. Those things won't be easy politically. If they were, they would have already been done by now.
If our leaders in Washington keep kicking the can, though, it will eventually turn into an oil drum.
What It All Means
We know what the latest political drama means for the economy. It will mean that growth is going to remain below potential.
The Washington drama certainly didn't do anything to lift business confidence or consumer confidence. Furthermore, the recognition that the debate over the budget and the debt ceiling will heat up again in just a few months seems likely to hang over businesses and consumers like a wet blanket.
Some economists think the impact of the shutdown on fourth quarter GDP could be about 0.5 percentage points. In other words, if they were looking for growth of 2.0% before the shutdown, they would now be projecting growth on the order of 1.5%. One thing to remember is that some of the drag will be mitigated by the fact that the shutdown happened early in the quarter and that furloughed federal workers will be receiving back pay. Pent-up spending potential, therefore, could ultimately lessen the expected impact.
Regardless, escape velocity won't be in the conversation in the fourth quarter and it probably won't be in the conversation in the first quarter of 2014 either.
Everything and nothing changed on the political front with the latest agreement.
What that ultimately means for the stock market is that the FOMC is unlikely to announce a tapering of its asset purchases until sometime in 2014 at the earliest. With the impending change in leadership at the Fed, some pundits have suggested a tapering will be deferred past the first quarter.
It is that understanding that will continue to underpin the stock market and embolden the buy-the-dip mentality.
In brief, because everything and nothing changed on the political front, everything and nothing changed for the stock market that rallied to the doorstep of new all-time highs as Congress, which deserves a kick in the can, once again kicked the fiscal can down a short road.