By Libby Cantrill, Managing Director, Head of U.S. Public Policy at PIMCO
· What is happening? Over the past few weeks, we have been of the view that a U.S. government shutdown in October looked more likely than not. Ironically, the Fitch downgrade of the U.S. debt from AAA to AA+ increases the chances of a government shutdown this fall. That’s because the downgrade is only likely to harden the views of House Republicans who are pushing for more significant spending cuts than what was agreed upon in the bipartisan debt limit bill. Of course, a government shutdown would be ironic since part of the reason for the Fitch downgrade was “political standoffs” like government shutdowns.
· But, but, but: While a government shutdown has short-term economic impacts, they are typically short-lived and reversed when the government reopens. Having said that, a government shutdown could coincide with a noisy fall from an economic perspective and could potentially exacerbate an already economically uncertain period, which will see the resumption of student loan payments for an estimated 45 million student loan borrowers as well as a federal tax bill for many taxpayers who have not had to pay 2023 taxes due to living in emergency disaster zones (here). We also will likely see the practical impact from credit tightening from regional banks, plus a data-dependent Fed.
· And still: Even if the government were to shut down and House Republicans were able to secure the cuts they want to, it would do little to change the fiscal trajectory, since in order to do so, entitlements (which accounted for 66% of the budget last year) would have to be reformed, which is currently a non-starter (see examples here and here).
· Bottom line: Upon their return in September, the House and Senate have 12 legislative days to pass 11 appropriations bills. While the Senate is in better shape, having passed nearly all 12 appropriations bills out committee (and almost all of them unanimously), there simply won’t be time to reconcile the differences between whatever the House passes and the Senate bills. Typically, a ‘continuing resolution’ would be used as a stop-gap measure to fund the government at current levels and buy more time. However, it is unlikely that House Republicans, especially the House Freedom Caucus, will support this as they see more political opportunity in advocating for fiscal restraint and potentially shutting down the government. Nonetheless, if a shutdown were to occur, we believe it would likely end by January 1st, which is the real deadline to fund the government. If “regular” appropriations bills have not been passed by then, a 1% across-the-board sequester would go into effect as part of the debt ceiling deal.
