On day 11 of the federal government shutdown financial markets are reacting optimistically to the news of a new round of budget discussions. Stock prices rallied through the second half of the week. Yields on Treasury bills have receded. The conventional wisdom is that things don’t get serious unless we get into next week without at least a temporary deal to extend the debt limit. Some politicians are acting as if a deal soon is a fait accompli. Because financial markets are, to a certain extent, already looking past a default crisis, the consequences of a black swan event could be large. As Yogi Berra said, “It ain’t over till its over.”
The federal-shut-down-induced data drought is happening at a bad time (as if there was ever a good time). We are flying blinded into a potential storm. Fortunately, data from private sources and from the Federal Reserve is flowing as usual. In an unfortunate coincidence, an important high frequency economic indicator that is still being published, unemployment insurance claims, has been corrupted by computer problems in California. Initial claims for unemployment insurance for the week ending October 5 increased by a whopping 66,000. About half of the big jump in claims is attributed to the technical issue in California. About half of the remaining half, or about 15,000-20,000 claims, can by attributed to the impact of the federal government shut-down on nonfederal employees.
Drags to the economy can be grouped into three areas: 1) direct real effects of reduced federal spending, 2) indirect real effects and 3) psychological effects. The direct real effects are felt through the loss of wages to furloughed employees and the suspension of contracts that support discretionary programs. The economic drag from direct effects is relatively small. Indirect effects are losses to the private-sector not directly associated with government programs. An example of this would be losses to international trade because import and export paperwork is not being processed. The psychological effect of the government shut-down is a damper on both business and consumer confidence.
Estimates of a 1 to 2 basis point per day drag on annualized real GDP growth in the fourth quarter seem reasonable. If we take the high end of the range, a 15 day federal government shutdown will cost us 30 basis points on Q4 real GDP growth. Our pre-shut-down estimate was for 2.5 percent annualized real GDP growth. We now shave that down to 2.2 percent if we have a quick resolution.
The Federal reserve is paying attention. It is unlikely that the FOMC will begin to dial down QE3 at its upcoming October 29/30 meeting. The next meeting, over December 17/18, is a more likely start to the taper.
For a PDF version of the Comerica Economic Weekly, including forecast tables and the variables calendar, click here: CMAEconWeekly101113.