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The relatively anticlimactic resolution – and quick passage – of the debt ceiling increase may have been expected, but it is still notable. Expected because Republican leaders – having learned a painful lesson from the last fiscal fight in which the government was shut down and the U.S. was pushed to the brink of potential default – were not inclined to impose another self-inflicted wound, especially in an election year in which they hope to realize significant gains in Congress. At the same time, the resolution is notable because it marks an “all clear” signal from Washington for the rest of 2014. Indeed, investors can expect a more normalized policy environment in Washington in the year ahead – no more talk of default, no more government shutdowns and no more governing from crisis to crisis. This, coupled with significantly less expected drag on economic growth from fiscal policies, might result in a much-needed respite from the uncertainty and economic headwinds emanating from Washington over the past several years. The debt ceiling resolution: clean and quick Unlike previous resolutions that ultimately raised the debt ceiling, but only after much brinksmanship, drama and, in some cases, significant policy concessions (e.g., the sequester in August 2011), the most recent agreement to raise the debt ceiling was both “clean” and quick. Clean in that Speaker John Boehner did not attempt to attach any policy provisions – such as the defunding of Obamacare – in exchange for the increase, instead opting from the outset for a clean bill that simply raised the debt ceiling for 13 months until March 2015 (not coincidentally, several months after the midterm elections). The resolution was also comparatively speedy versus the previous drawn-out, eleventh-hour fiscal battles: The bill sailed through both chambers in a matter of two days (albeit with a vast minority of Republican support) and almost a full two weeks before the expected deadline.
A 2014 government shutdown? Unlikely With the debt ceiling a non-issue until next year, focus might turn to the next potential fiscal inflection point and possible opportunity for market disruption in 2014: the expiration of government funding at the end of the government’s fiscal year in September. Can we expect a repeat of last fall’s showdown over government funding that precipitated the shuttering of the government for 17 days? Not likely. For one, the deadline falls little more than a month before the midterm elections in which Republicans will seek to hold their majority in the House and pick up seats in – if not win back – the Senate, making an unpopular government shutdown very unattractive. Somewhat related, the non-binding budget framework agreed upon by Representative Paul Ryan and Senator Patty Murray and endorsed by Congress last December set funding levels for both 2014 and 2015. While it is certainly possible that each party rejects the already agreed-upon funding levels for 2015, it is highly unlikely. Why would either party want to reopen and undermine the only significant bipartisan compromise fashioned in this Congress and potentially invite substantial public criticism (again right before an election)? Instead, we expect a rather uneventful – and likely speedy – passage of a government funding bill for 2015 at spending levels close to the agreed-upon targets set out in the Ryan/Murray budget framework.
And less fiscal drag, too In addition to fewer fiscal fights in 2014, we also expect Washington to do less harm from an economic growth perspective. Last year, the combination of the payroll tax cut expiry (effectively an across-the-board tax increase for the vast majority of working Americans), an increase in taxes on upper income earners, and the mandatory, across-the-board sequester cuts resulted in a collective drag on economic growth of roughly 1.3% of GDP.
2014, however, is a different story: Fiscal headwinds will still exist, but they will be significantly diminished compared with those in 2013. We estimate that fiscal drag in 2014 will be about 0.4% of GDP, and possibly lower if Congress decides to reinstate federal emergency unemployment benefits – something congressional Democrats have vowed to do. Additionally, with the U.S. deficit expected to decrease to around 4% of GDP, close to its 40-year average, we expect the almost singular focus on austerity we saw from many politicians over the past few years to abate. This means policies such as the sequester’s forced spending cuts will likely have considerably less political support going forward.
At the same time, let’s temper our enthusiasm for Congress Less policy uncertainty, fewer disruptive fights over fiscal policy and fewer headwinds to economic growth from government policies sounds pretty great, especially when considering the policymaking context of the past several years. However, we should certainly not overstate our optimism for Congressional activity. Yes, Congress will likely do no harm – or at least a lot less harm than they have in previous years – but at the same time, Congress will likely do very little that is constructive for the economy in the year ahead. While hope springs eternal, aspirations for ambitious legislation such as tax reform, a GSE (government-sponsored enterprise) overhaul, an infrastructure spending bank or immigration reform will likely remain unrealized in 2014.
Nevertheless, considering what we have seen out of D.C. over the past few years and given how low expectations for Congress have become, most investors should be sufficiently satisfied if Congress simply gets out of the economy’s way.
This material contains the opinions of the but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2014, PIMCO.
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