Before I dive into the heart of the matter, I’d like to make very clear that I am NOT providing an opinion on the politics of this situation; I leave that to other, far more capable political strategists. However, for the sake of the economy, we need a budget deal. And, frankly, we need it now for a number of reasons.
First, the economy is already softening. While the coincidental economic numbers are still very strong, we’ve seen some weakness in the leading indicators for the last 3-5 months. Credit spreads are higher, building permits are a bit softer, the equity markets have sold-off (although they are currently rebounding modestly), and the yield curve continues to flatten. These events are all standard, end-of-economic-cycle developments. This does not mean a recession is certain: I’ve got a 25% recession probability in the next 12-18 months; the NY Fed’s recession model is a touch lower at 21%. However, it does mean that the possibility is now higher.
There is also anecdotal data showing softer US data. For the second consecutive report, the Federal Reserve’s Beige Book contained a number of weaker comments (emphasis added):
Economic activity increased in most of the U.S., with eight of twelve Federal Reserve Districts reporting modest to moderate growth. Nonauto retail sales grew modestly, as several Districts reported more holiday traffic compared with last year. Auto sales were flat on balance. The majority of Districts indicated that manufacturing expanded, but that growth had slowed, particularly in the auto and energy sectors. New home construction and existing home sales were little changed, with several Districts reporting that sales were limited by rising prices and low inventory. Commercial real estate activity was also little changed on balance. Most Districts reported modest to moderate growth in activity in the nonfinancial services sector, though a few Districts noted that growth there had slowed. The energy sector expanded at a slower pace, and lower energy prices contributed to a pullback in the industry's capital spending expectations. The agriculture sector struggled as prices generally remained low despite recent increases. Overall, lending volumes grew modestly, though a few Districts noted that growth had slowed. Outlooks generally remained positive, but many Districts reported that contacts had become less optimistic in response to increased financial market volatility, rising short-term interest rates, falling energy prices, and elevated trade and political uncertainty.
Consider these phrases from the above paragraph::
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sales were flat on balance
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sales were limited by...
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growth had slowed...
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lower prices contributed to a pullback...
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growth had slowed
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contacts are less optimistic
NS On Friday, we learned that the University of Michigan’s Consumer Index for future events dropped 10% — a very significant decline.
Second, there is a tremendous amount of global uncertainty. Brexit has a hard date of March 29 and the UK has absolutely no meaningful plan to deal with it. Recent data from the EU indicates that the region is experiencing a sudden slowdown in industrial activity. The US and China are still trying to solve their trade issues, which are very complex. These situations are already negatively impacting C-suite sentiment, lowering investment spending and hiring decisions.
Third, while the amount of the predictions vary, there is universal agreement that the slowdown will hurt 1Q19 economic growth. The White House sees a .13% drop/week of the slowdown. Macroadvisors has dropped their growth projection by 1.4%. NY Fed Governor Williams has the drop at 1%. Regardless of which economic model you use, a drop in government spending hurts growth. There are two generally-accepted models of the macro-economy: aggregate demand/aggregate supply (AD/AS) and the investment-savings/liquidity money supply (IS/LM). Both models contain all the elements of GDP: the AD and IS line can be thought of as consumer spending (PCE)+invetment (I)+ net exports (X) + government spending (G). The shutdown lowers (PCE) and (G) and will eventually start lowering (I). This shifts the AD and IS curves to the left, lowering growth. Yes, it’ s that simple.
Again — I’m not commenting on the politics of the situation. But the economic damage has already occurred. And the longer we remain at an impasse, the worse it will get. The situation needs to be solved. Now.