Government Impasse: Lost Revenue, Complications for the Fed

The U.S. government is poised for a federal shutdown, the first of its kind since 2019, potentially costing American taxpayers billions of dollars. There is still time to avert a shutdown, but with less than a week to pass a short-term spending bill needed to keep the government open past the new fiscal year beginning October 1, most are skeptical there is the will to negotiate, and quickly.  

The consequences of a shutdown are many including an erosion of confidence in government officials and voter frustration as the 2024 election rapidly approaches, as well as a significant waste of resources. According to the Senate Homeland Security and Governmental Affairs Committee, the last three government shutdowns cost taxpayers a total of near $4 billion including billions in back pay to furloughed workers as well as millions in fees, lost revenue and late fees on interest payments.  

House Speaker Kevin McCarthy has struggled to make meaningful progress in negotiations, already twice defeated, failing to rally the needed support from the far Right insisting on steep spending cuts. With few options left, House Republicans are said to be considering a stopgap measure that would continue to fund the government for a minimal 14 to 60 days, but the near 30% spending cuts included in the provisions would largely make it dead on arrival in the Senate.  

Meanwhile, over the weekend top Democrats were clear where the blame for the impasse falls, calling for Republicans to put their "differences" aside as "funding the government is one of the most basic responsibilities of Congress." Of course, excluding judgment of near-term actions, with the government's balance sheet topping $31T in FY 2022, growing 94% in the past 10 years, with debt servicing costs rising to 7.5% of the budget and expected to rise to more than 10% in the next decade, it is understandable that many see reining in the size of the government’s balance sheet as the top priority for longer-term stability regardless of the very short-term disruptions. Such volatility will after all no doubt compound pressure on investors already facing an uncertain outlook for the economy and policy, and furthermore complicate the landscape for the Federal Reserve to continue to rise rates, at last nearer term.  

Equities ended the week lower with the Dow falling 1.9%, the S&P 500 dropping 2.9% and the Nasdaq Composite declining 3.6%. The S&P 500 and Nasdaq marked their largest intra-month decline since March in the aftermath of the collapse of Silicon Valley Bank. Treasury yields, meanwhile, remain elevated, as the Fed continues to tout the need for a higher for longer scenario. The 10-year Treasury, for example, rose to a peak of 4.5% last week, the highest since 2007, before closing the week at 4.45%. As of 8:54 a.m. ET, the 10-year is currently trading at 4.50%.  

Perpetuating the notion of higher rates, Boston Fed President Susan Collins said interest rates will likely remain elevated as the battle against too-high inflation continues. Speaking at a Maine Bankers Association event on Friday, Collins said, “I expect rates may have to stay higher, and for longer, than previous projections had suggested, and further tightening is certainly not off the table.” 

Similarly, speaking at an Independent Community Bankers of Colorado event on Friday, Governor Michelle Bowman also voiced support for ongoing elevated rates in today’s inflationary environment. While she noted there has been progress, such progress, she said, has not been sufficient in bringing inflation down to the Fed’s 2% target. “I continue to expect that further rate hikes will likely be needed to return inflation to 2% in a timely way,” she said. 

Additionally speaking on Friday, Minneapolis Fed President Neel Kashkari noted that the U.S. consumer continues to exceed expectations. According to Kashkari, “I would have thought with 500 basis points or 525 basis points of interest rate increases, we would have slammed the brakes on consumer spending and it has not slammed the brakes on consumer spending."

On the economic calendar on Friday, the S&P Global U.S. Manufacturing PMI rose one point to 48.9 in September, more than the expected gain to 48.2, but still the fifth consecutive month below a reading of 50. The U.S. Services PMI, meanwhile, declined slightly from 50.5 to 50.2, but continues to remain in expansionary territory, with the Composite PMI dipping from 50.2 to 50.1 in September, a seven-month low.

This morning, the Chicago Fed National Activity Index unexpectedly dropped from 0.07 to -0.16 in August, a two-month low. According to the median forecast, the index was expected to rise to 0.10. The Chicago Fed Index draws on 85 economic indicators; a reading below zero indicates below-trend growth in the national economy and a sign of easing pressures on future inflation. In August, 35 of the 85 monthly individual indicators made positive contributions, while 50 made negative contributions.

Tomorrow, on the heels of disappointing supply-side housing data last week, August new home sales are expected to decline 2.2% following a 4.4% gain the month prior. Also tomorrow, the S&P CoreLogic 20-City Home Price Index is expected to rise 0.70% in July following a 0.92% gain the month prior, and the Conference Board’s Consumer Confidence Index is expected to decline from 106.6 to 105.5 in September.

The key reports of the week, however, begin on Wednesday with a look at August durable goods. Last month, durable goods orders fell 5.2% in July, more than reversing the 4.4% headline rise in June. Year over year, durable goods remain in the black, albeit modestly, up 3.7%. Capital goods orders excluding aircraft and defense, a proxy for business investment, rose 0.1% and 0.8% year-over-year.

On Thursday, GDP is expected to be revised up to a 2.2% gain in the final Q2 report after a downward revision from 2.4% to 2.1% in the second-round report.

Finally, on Friday, August personal income and consumption and the all-important PCE reports will be released. As the Fed noted last week, there has been considerable progress in terms of taming inflation from earlier peak levels. However, inflation remains too high. Headline inflation is expected to rise from 3.3% to 3.5%, while the core, which excludes food and energy, expected to decline from 4.2% to 3.9%.

-Lindsey Piegza, Ph.D., Chief Economist