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Fiscal Uncertainties Are Weighing on Companies’ Expectations

Last Friday, the House of Representatives voted (203-189) to approve a stopgap spending bill to fund the government through mid-December. Indeed, in order to extend the current government spending at the current rate and to avoid a “government shutdown” after September 30, Republicans-controlled House chose to attach a provision to dismantle President Obama’s health care law “Obamacare”.

 

However, the provision has no chance of approval as it will face a veto from President Obama in the Democrats-controlled Senate. Today, the Senate should begin to debate on the spending bill where Senate Majority leader Reid (D-NV) will reject the provision and will send the bill back to the House.

 

Nevertheless, even if Democrats and Republicans find a compromise on a temporary bill until mid-December, they will need to specify the 2014 budget. The fact is Democrats want to spend $1,058 billion for fiscal 2014 while the budget control acts sets spending caps at $967 billion ($109 billion of sequestration). Some want to meet the spending caps by allocating more on defense and less to civilian programs. Finally, some Republicans are asking for larger cuts to entitlement programs, to which Obama is unlikely to agree. The only good news is that, in the worse case, sequestration will not happen until January (after Congress holidays).

 

Moreover, concerning fiscal issues, some press reports suggest that House of Representatives will also try to vote on debt limit this week as the Treasury Department predicts the debt ceiling will be reached by mid-October. The legislation would seek to increase the debt ceiling until Dec-2014 and likely include approving the Keystone XL pipeline, reforming the corporate and households’ tax code, delaying “Obamacare” and eliminating the Consumer Financial Protection Board (CFPB). Remind that if Congress does not reach a deal to raise the debt limit, a default and/or debt downgrade could ensue.

 

Debates are already weighting on companies’ expectations. The BRT’s (Business RoundTable) third quarter CEO Economic Outlook Survey, released on September 18, show slightly more optimism about the economy with lower expectations for sales and capital investment. Note that the composite index fell to its lowest level since 4Q 2012.

 

 Source: Business RoundTable

 

 Source: Business RoundTable

 

The survey which included an additional question concerning the effects of political stelmate show that 50% of respondents indicated that the ongoing disagreement in Washington is having a negative impact on their plans for hiring additional employees over the next 6 months.

 

In this context, my view remains that growth could be sluggish at least until Congress validates the stopgap bill and raises the debt ceiling (mid-October/beginning of November). As a consequence, Fed policy will remain accommodative so that “tapering” will not start before December.

Eight Reasons Why the Fed Will Not “Taper” in September (An Update)

Just before the FOMC statement on September 18, I think it’s interesting to make an update of my post concerning arguments against “tapering”.

 

Indeed, notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are still legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

-> Senate Majority Leader Harry Reid said last Thursday that deep divisions within the House Republican caucus are imperiling passage of a fiscal year 2014 stop-gap spending bill and threaten both a government shutdown and a default. Note that this bill would keep the government funded until Dec 15 and should include sequestration of $109 billion.

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).

 

-> The last statistics (August retail sales, Wholesale inventories…) suggest that actual growth (3Q) is below 2%.

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

-> Mortgage applications decreased 13.5 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending September 6, 2013 (14 declines recorded in the last 17 weeks). The Refinance Index decreased 20 percent from the previous week and has fallen 71 percent from its recent peak (the week of May 3).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K

- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.

 

6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.

 

-> A diplomatic breakthrough Saturday on securing and destroying Syria’s chemical weapons stockpile averted the threat of U.S. military action for the moment. It means that Syrian conflict is not a longer an argument against tapering.

 

7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.

 

8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.

- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.

- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.

- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.

 

To replace my argurment on Syrian conflict, I choose to focus on future changes at the head of the Fed.

 

8bis/ Changes at the head of the Fed in 2014. The next year, the voting members will be more “hawkish” with the arrival of Fisher (Dallas Fed President) and Plosser (Philadelphia Fed President). Therefore, knowing that committee in place in 2014 would quickly end the asset purchases program, the actual committee could delay “tapering” to compensate.

Boehner Will Propose Short-Term Bill to Avert Government Shutdown but Will Maintain “Sequester”

As everybody knows, Republicans and Democrats had been expected to clash in September over funding for federal operations, ahead of the Oct. 1 (start of the new fiscal year). In a context where public finances are improving significantly, Democrats seem ready to avoid budget cuts or even increase spending in some areas while Republicans still want to limit expenses.

 

On a conference call Thursday evening with GOP lawmakers, House Speaker John A. Boehner said it was his “intent to move quickly” when lawmakers return to Washington in September to propose a short-term spending bill that keeps the government running for 60 to 75 days and therefore avert a “government shutdown”. In this context, lawmakers could defer the toughest budget issues to later in the fall, when lawmakers should face a deadline to raise the debt ceiling, according to CBO estimates. Yet, this budget bill will maintain sharp automatic spending cuts ($109 billion) which should entry into force from October 1st.

 

More from Washington Post:

 

House Speaker John A. Boehner said Thursday that he plans to avert a government shutdown at the end of September by passing a “short-term” budget bill that maintains sharp automatic spending cuts, known as the sequester.
 
“Our message will remain clear,” Boehner said. “Until the president agrees to better cuts and reforms that help grow the economy and put us on path to a balanced budget, his sequester — the sequester he himself proposed, insisted on and signed into law — stays in place.”

After Fiscal Mess, Uncertainty Concerning Monetary Policy is Coming in US

According to FT, Larry Summers, which is now seen as the front-runner to replace Fed Chairman Bernanke, made dismissive remarks about the effectiveness of quantitative easing at a conference in April, raising the possibility of a big shift in US monetary policy.

 

More from FT:

 

“QE in my view is less efficacious for the real economy than most people suppose,” said Mr Summers according to an official summary of his remarks at a conference organised in Santa Monica by Drobny Global, obtained by the Financial Times.
 
Mr Summers – who served as President Barack Obama’s chief economic adviser from 2009-2010 – has seldom spoken in public about monetary policy. Markets have little sense of his current thinking and may be surprised by his apparently hawkish stance on QE.

 

The disclosure of his remarks comes as the race for the Fed chairmanship is widely regarded as being between Mr Summers and Janet Yellen, the current Fed vice-chair, who has been an architect of its QE policies. The fact is that even if even Larry Summers seems to be backed by President Barack Obama, that’s not the case for a number of US Senate Democrats who sent a letter supporting Janet Yellen as the next Fed Chairman.

 

More from FT:

 

A number of US Senate Democrats are circulating a letter supporting Janet Yellen to be the next chair of the Federal Reserve in an ominous sign for supporters of Larry Summers.
 
The letter has been pushed by Sherrod Brown from Ohio, Senate officials said, one of the chamber’s leading liberals and a longtime critic of financial deregulation and trade liberalisation.
 
Signatories include Tom Harkin of Iowa, and Dianne Feinstein of California.
 
Senate officials said a single copy of the letter had been circulated to the chamber’s 54 Democrats. It is not known how many senators have signed the letter.

 

The second story shows that there could be some tensions in the Democrat Party in a context where President Barack Obama will confront with lawmakers (after a long August holiday) on a daunting list of decisions affecting the economy (“continuing resolution”, 2014 fiscal budget, fiscal consolidation plan and debt ceiling) and therefore will need the full support of his party. If he remains isolated and unable to find a compromise with Republicans, automatic, across-the-board budget cuts of $109 billion, could entry into force on October 1st.

 

In the meantime, if Larry Summmers is chosen, it could apply a less accommodative monetary policy which could increase uncertainty and the fear of a return into recession.