U.S. government closed for business?

The U.S. Government goes in to shut down

As we mentioned in our latest market commentary, the U.S. had until midnight yesterday to reach a decision regarding the budget.  Many were expecting a last minute deal to be reached, which is usually the case with the U.S.  However, yesterday Congress failed to reach a decision and the political deadlock has led to a shutdown in some government services.

What’s caused the deadlock?

Essentially, the Republicans want to delay Obama’s 2010 healthcare reforms as a condition for passing a bill.  They made it quite clear that they would only vote on the bill if the Democrats agreed to delaying Obamacare for a year.  The democrats don’t want to make any concessions on this as it is essentially one of Obama’s key achievements.  This has led to political gridlock and the first partial government shutdown in 17 years.

What Impact will this have?

The shutdown has meant that about 800,000 federal employees will now be temporarily suspended from work without pay.  Many museums, national parks and zoos have been shut down and staff have been affected across defence, commerce, energy and transportation sectors.  Bloomberg has estimated that the shutdown will cost the economy $300 million a day in lost economic output.  Yet, most economists are under agreement that provided the shutdown is short lived, the impact on the economy will be modest.  What’s more important however, is the debt ceiling issue just around the corner which we’ll come on to explain.

Market Reaction

The market reaction to the news has been rather subdued so far.  At the time of writing, the FTSE 100 is down 0.10% from its opening price this morning, the S&P 500 is up 0.70% and many of the European indices are also up.  We have seen markets begin to price in some of these issues over the last week as the FTSE 100 has steadily declined by about 0.5%.  Markets have also to some extent become accustomed to political standoffs as we went through a similar scenario in 2011 and in addition, many investors are far more interested in what will happen between now and the 17th October 2013, when the debt ceiling will need to be reviewed.

The bigger issue – the debt ceiling

Most would agree that the bigger issue markets will face is the debt ceiling.  The limit on how much the U.S. can borrow will be reached on 17th October and an agreement is needed to be made in order for a default to be averted.  Considering the U.S. government have failed to reach a decision regarding the budget, what does this mean for the bigger decisions when the borrowing limit will need to be reviewed?

Our views

Accepting we are long term investors and the fact that it is difficult to envisage what politicians will do (as seen yesterday), we do not intend to take a defensive stance at this point in time.  What’s different this time round is that the U.S. economy is essentially in a much stronger position than it was in 2011 and any problem that we will be facing mid-October could be solved in the blink of an eye, which is something we would be unable to time.  The positive economic data that has been coming out of the U.S. suggests to us that we should continue to ride out the volatility and focus on the longer term strategy.