FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
November 28, 2017
- First Trust Report: The US Economy is Accelerating
- GOP Tax Cut Obsession Could Jeopardize Debt Limit Vote
- Republican Options Are Limited, Democrats Know This
- Why Another Shutdown So Quickly? Politics, of Course
Here we go again. Another government shutdown could occur in January. Current federal funding expires on December 8, a week from this Friday, and the Treasury Department can only employ so-called "extraordinary measures” to fund the government until sometime in January. If nothing is done beyond that, major parts of the government will shut down.
I know, we’ve seen these threats of a government shutdown come and go, and with a few exceptions, we usually avoid them. Something usually gets done at the last minute, but this time could be different. Why is that?
Republicans in Congress are laser-focused on passing tax reform before the Christmas recess. As such, I worry that they may not take the time to garner the Democrat’s support they’ll need to pass a spending measure to fund the government beyond January. Democrats on the other hand, may not be opposed to a government shutdown in January because they can blame it on the Republicans.
I hope I’m wrong because the threat of a government shutdown in January could wreak havoc on the stock and bond markets, at least temporarily. Both markets are well overdue for a significant downward correction, and a government shutdown would almost assure that we get one.
Before we get to that discussion, I want to share with you the latest economic assessment from Brian Wesbury and Robert Stein, Chief Economists at First Trust. I read their analyses each and every week. Having referred to the slow but steady US recovery as a “Plow Horse” economy for the last several years, Wesbury and Stein now believe the economy has accelerated into a new gear this year. In last week’s report, they explain why. Here it is.
First Trust Report: The US Economy is Accelerating
“Monday Morning OUTLOOK: The Economy is Accelerating
We’ve called it a “Plow Horse” economy, which was our metaphor invented to counter forecasters who said slow growth meant a recession was on its way. A Plow Horse is always slow, but that slowness hides underlying strength – it was never going to slip and fall. Now, the economy is accelerating.
Halfway through the fourth quarter, monthly data releases show real GDP growing at a 3%+ annual rate. If that holds, it would make for three consecutive quarters of growth at 3% or higher. Believe it or not, the last time that happened was 2004.
Last week saw retail sales, industrial production, and housing starts all come in better than expected for October, the latter two substantially better.
And while retail sales grew “just” 0.2% in October, that came on the back of a 1.9% surge in September. Overall sales, and those excluding volatile components like autos, gas and building materials, all signal a robust consumer.
Meanwhile factory output surged 1.3% in October, tying the second highest monthly gain since 2010. Production at factories is now up 2.5% from a year ago, and accelerating. By contrast, factory production was down 0.1% in the year ending October 2016 and unchanged in the year ending October 2015. The current revival is not due to the volatile auto sector, where output of motor vehicles is down 5.9% from a year ago while the production of auto parts is down 0.3%.
The last piece of last week’s good economic news was on home building: housing starts surged after a storm-related lull in September. Single-family starts, which are more stable than multi-family starts -- and add more per unit to GDP -- tied the highest level since 2007. Housing completions hit the highest level since 2008.
As a result of all this data, the Atlanta Fed’s “GDP Now” model says real GDP is growing at a 3.4% annual rate in Q4. The New York Fed’s “Nowcast” says 3.8%.
Of course, if we get anything close to those numbers, some analysts will claim the fourth quarter is just a hurricane-related rebound. But the conventional wisdom has been way too bearish for years, and Q3 is likely to be revised up to a 3.4% growth rate from the original estimate of 3.0%.
Put it all together, and things are looking up. It’s no longer a Plow Horse economy. In fact, after years of smothering the growth potential of amazing new technologies, the government is finally getting out of the way.
The Obama and Bush regulatory State is being dismantled piece by piece, and spending growth has slowed relative to GDP. Tax cuts are moving through Congress. These positive developments have monetary velocity – the speed at which money moves through the economy – picking up. “Animal spirits” are stirring. We don’t have a cute name for it, but growth is accelerating.
This reduction in the burden of government would be easier, and much more focused on growth, if Republicans had fixed the budget scorekeeping process when they first had the chance back in 2015, or even in the mid-1990s, after having gained control of both the House and Senate.
Instead, they took a cowardly pass. As a result, when assessing the “cost” of tax cuts, Congress still ignores the positive economic effects of tax cuts on growth. Oddly, while refusing to “score” better GDP growth, we understand the budget scorekeepers assume tax cuts lead to higher interest rates, which add to the cost of the tax cuts. In effect, the scorekeepers will use dynamic models to count the negative effects of tax cuts on the overall economy, but not the positive ones!
This kind of rigged scoring system is why the current tax proposals don’t cut tax rates on dividends or capital gains, and why some of the tax cuts are temporary. It’s also why the top tax rate on regular income for the highest earners is likely to end up near the current tax rate of 39.6%.
We were never satisfied with Plow Horse growth, but we always thought it showed the power of innovation. The power of new technology caused the economy to grow since 2009, despite the burden of big government.
Now with better policies, growth is on the rise. We haven’t fixed enough problems to get 3% real growth in every quarter, and maybe not even as the average growth rate over time. That would probably take some major changes to entitlement spending programs. But the recent improvement is hard to miss and signals that entrepreneurship is alive and well in the United States.” END QUOTE
GOP Tax Cut Obsession Could Jeopardize Debt Limit Vote
Republicans in Congress and the mainstream media (pro and con, respectively) are so focused on passing/killing a massive tax overhaul this year that they’re saying little publicly about the potential January government shutdown. That’s when major parts of the government will shut down if the GOP can’t reach a deal with Democrats on federal spending.
A lot has to get resolved between now and then. Even if there is some movement on extending federal funding beyond January, such as another “continuing resolution,” there is no guarantee that President Trump will sign it. The president is demanding that any new budget extension include funds for a US-Mexico border wall.
Any budget resolution will require some Democratic support, and the Dems have some red lines of their own. For example, Democrats insist on continuing Obamacare subsidies and protection for young undocumented immigrants – among other hot-button issues – before enough Dems will sign-off on any budget extension.
So the next few weeks will be a crucial test for Republicans seeking to prove to voters they can fund the government and fulfill major campaign promises such as their pledge to cut Americans’ taxes. The GOP is eager for a legislative victory before the end of this year. That’s why I worry we could see another government shutdown just ahead.
Tom Cole, an Oklahoma Republican on the House Appropriations and Budget Committee recently warned: “Right now it’s all hands on deck for tax reform, and I understand that, but we’ve got to get some sort of bipartisan agreement so the appropriators have enough time to actually put together a bill to fund the government [before a January shutdown].”
Republican Options Are Limited, Democrats Know This
GOP leaders may continue to pursue the tax overhaul now and put off major spending decisions until early 2018 by passing a “stopgap” short-term funding bill. Yet they will still need some Democratic votes for even a stopgap bill -- and the Democrats won’t make it easy. As noted above, they will likely demand securing Obamacare and young immigrant protections in exchange for keeping the government open.
Government shutdowns have had little impact on financial markets as long as the bills keep getting paid. Yet as it stands now, that will end in January if new action isn’t taken by lawmakers. In any event, the Treasury bill market is beginning to show signs of angst about when the Treasury might have to again curtail borrowing after the current US debt ceiling suspension ends late next week.
Short-term investors are demanding more for Treasury debt maturing in early February to avoid being caught holding securities that are vulnerable to a technical default once “extraordinary measures” allowing the government to fund itself expire in January. Again, we’re not hearing much about this yet, but concerns will increase each week moving forward.
Senate Minority Leader Chuck Schumer (D-NY) reported recently that Republican and Democratic leaders have started negotiating over a new spending bill, but they are still far apart. Democrats have some leverage because Republicans don’t have a filibuster-proof majority in the Senate, and some House GOP members are sure to vote against compromise spending bills.
One major dispute is over Republicans’ bid to increase military spending. Yet if the GOP continues to pursue increased military spending, then the Democrats will insist on an equal increase in non-military spending. So, it would take major concessions to get the Dems to sign off.
House leaders from both parties admitted last week that talks on raising the spending caps “aren’t going well.” This is another reason I fear that a government shutdown is a greater threat this time around – one that could result in a potentially serious market correction.
Why Another Shutdown So Quickly? Politics, of Course
The December 8 budget deadline was set in a deal Democrats Chuck Schumer and Nancy Pelosi struck with Trump -- against Republican leaders’ wishes -- to avoid a government shutdown and debt default back in September. They agreed to fund the government at current levels and suspend the debt limit for only three months.
US Treasury Secretary Steven Mnuchin can use ‘extraordinary measures’ to stretch government finances beyond December 8, and he says he’s “comfortable” that federal borrowing capacity won’t run out before sometime in January.
Since the September budget deal, President Trump has taken unilateral actions to reverse policies enacted by former President Barack Obama, in some cases asking Congress to come up with a legislative solution. These issues could get wrapped into the spending plan.
For example, Mr. Trump announced he’s ending Obama’s program that protects undocumented immigrants brought to the US as children from being deported. He gave Congress six months to draft legislation providing permanent protection. In addition, he is demanding $1.6 billion for a wall on the southern US border, which Democrats say is a deal killer.
House Speaker Paul Ryan said he’ll seek a compromise to pair child-immigrant protections with more funds for border security and immigration enforcement. But Mr. Ryan’s compromise is a far cry from meeting Trump’s demands, so there’s no reason to think President Trump will sign such legislation.
I know this sounds like politics as usual in Washington, but it could potentially lead to a real government shutdown that could be very negative for stocks and bonds in the weeks ahead.
All the best,
Gary D. Halbert