With political uncertainty near record highs (but equity market uncertainty near record lows), Goldman's Jan Hatzius analyzes the four biggest political risks receiving the most attention from market participants (and stand to create the most chaos if the priced for perfection market is disappointed).
Via Goldman Sachs,
Q: What are the near-term risks on the agenda in Washington?
There are four risks we are monitoring that have recently received some attention from market participants:
1. The outlook for legislation to replace the Affordable Care Act (ACA, or “Obamacare”) remains unclear and risks delaying congressional action on tax reform.
2. The nomination of Neil Gorsuch to become a Justice on the Supreme Court is expected to move through the Senate Judiciary Committee this week, on its way to the Senate floor the week of April 3. If his confirmation is blocked, it could result in a change in Senate rules that could create a temporary political disruption.
3. Congressional appropriations expire April 28, and must be extended by then to avoid a temporary government shutdown.
4. The debt limit was reinstated March 16, and must be raised later this year to avoid disruption to Treasury’s ability to borrow.
Q: Will Congress pass its healthcare bill within the next few weeks?
It’s possible, but we think it is more likely to take until at least May. On Thursday, March 23, the House is expected to vote on a modified version of health care legislation the House Budget Committee passed last week, which we described here. The upcoming House vote is hard to predict but passage looks more likely than not, in our view, as a result of political pressure from party leaders and policy changes expected to be incorporated into the version that comes up for a vote later this week.
However, the outlook in the Senate has not changed as much. Some centrist Republicans still appear to have concerns about how much the proposal would reduce insurance coverage, while some conservatives are opposed to a continuation of some of the current program’s subsidies, even with modifications. The Senate is tentatively scheduled to take up the ACA proposal next week (the week of March 27), but passage there appears more difficult, because with 52 Republican senators, they can afford to lose no more than two Republican votes (assuming Vice President Pence casts a tie-breaking vote in favor of the bill). The upshot is that the House and Senate are unlikely to be able to agree on a single final proposal that can be sent to the White House to be signed into law before the upcoming two-week congressional recess that starts April 10.
If the House passes the bill later this week, markets are apt to interpret this as a positive sign for the broader fiscal agenda, particularly tax reform, since Congress cannot formally begin consideration of tax reform until the ACA bill has been finalized. However, we note that the Senate, not the House, is the high hurdle and there continues to be a risk of delay in that chamber.
Q: What is the issue with the Supreme Court nomination?
President Trump’s nominee to the Supreme Court, federal appellate Judge Neil Gorsuch, will come before the Senate Judiciary Committee this week and his confirmation is expected to be put to a vote in the full Senate the week of April 3. If Democrats block the nomination, Republicans might move to change Senate rules regarding Supreme Court nominations in a procedure known as the “nuclear option”; in 2013, Senate Democrats used the same procedure to allow all other presidential nominations to be confirmed by a simple majority. Making this change would likely be interpreted by market participants as reducing the already low likelihood of bipartisan cooperation on certain aspects of the political agenda, like regulatory reform or infrastructure spending. In our view, this risk is likely to be avoided, as we expect that Senate Democrats will ultimately allow Gorsuch’s nomination to be confirmed, even though most are likely to vote against him. They could do this either by providing the incremental votes to reach 60 votes total, or by declining to filibuster the nomination, allowing it to be confirmed with a minimum of 51 votes.
Q: Why is the possibility of a government shutdown being discussed?
After the 2016 election, Congress enacted a temporary “continuing resolution” to extend government spending authority through April 28, 2017, to allow the new Congress and administration sufficient time after taking office to develop a spending plan for the remainder of the fiscal year. To avoid a government shutdown on April 29, Congress will need to pass a spending bill before then that funds the remainder of the fiscal year, or at least another short-term extension of spending authority if an extension for the remainder of the year cannot be agreed upon.
Q: How does this relate to the budget the President recently outlined?
In his budget submission to Congress last week, President Trump asked for $1.5 billion in funding for the border wall between the US and Mexico for the remainder of FY2017, and another $2.6 billion in FY2018. To fund construction of the wall, Congressional Republicans are considering adding the requested funding to the upcoming spending bill. Senate Democrats have already objected to the possibility of doing so, and have warned that they will not support the bill if it includes funds for the wall. Since congressional appropriations bills typically require 60 votes to pass in the Senate, Democrats could block the bill from becoming law if Republicans insist on the inclusion of border wall funding.
Q: Can’t the majority just pass spending bills through the “reconciliation” process?
No, the reconciliation process is traditionally used only for legislation affecting revenues or “direct spending” programs. When congressional leaders seek to pass fiscal legislation, they often use the budget “reconciliation” process to allow the bill to pass with a simple majority in the House and Senate. However, this process is traditionally reserved for tax legislation or changes to “direct spending” programs like Medicare, welfare, or credit programs. Moreover, it requires some advance planning, since “reconciliation instructions” must be included in the annual budget resolution that Congress is supposed to pass early each year. Congressional Republicans did not provide any reconciliation instructions related to FY2017 appropriations in the most recent budget resolution, so that procedural tool is not available to pass this bill.
Q: How does this relate to the fiscal debates Congress is having on ACA and tax reform?
The risk of a potential shutdown is essentially unrelated to the broader fiscal debates on health care and tax changes under discussion at the moment. While both of these are likely to be considered as part of the budget process, action (or inaction) on spending legislation is entirely unrelated to these broader fiscal debates. That said, if a shutdown were to occur, we assume it would distract at least temporarily from these other efforts.
Q: So will a shutdown occur?
At this point we would not expect a federal shutdown but the perceived risk of a shutdown seems likely to increase as the April 28 deadline approaches. In every notable government shutdown experience over the last few decades—the shutdown in October 2013, the two shutdowns in 1995-1996, and a string of short shutdowns during the Reagan/Bush terms in the 1980s—control of government was divided between Republicans and Democrats. With Republican control of Congress and the White House, the public seems likely to hold Republicans chiefly accountable. Knowing this, congressional Democrats are likely to object to any controversial provisions in upcoming spending bills. In theory, this should give the Republican majority incentive to avoid a shutdown by simply omitting those provisions.
However, there are two reasons Republican leaders might still include funding for the border wall or other controversial items. First, ahead of a midterm election where turnout is typically low and arousing enthusiasm among the political “base” is often seen as more important than expanding appeal among centrist voters, a political dispute over an issue like unauthorized immigration might be seen as advantageous. Second, President Trump’s proposal to build a border wall was central to his campaign, and including funding in must-pass legislation like the upcoming spending bill is the most obvious way for Republicans enact it into law. So while we would expect a shutdown over the proposed border wall or other controversies to be avoided, Republican leaders have an incentive to at least try.
Q: If a shutdown does occur, what would the effects be?
In 2013, we estimated that the shutdown reduced real GDP growth in the quarter it occurred by 0.2pp for each week the full shutdown lasted. Consumer and market sentiment was also negatively affected, though we would note that the effect of a shutdown next month would probably be less severe, as the 2013 shutdown coincided with a debt limit deadline that was likely the greater concern for financial markets.
Q: How does this relate to the debt limit?
The need to raise the debt limit is totally unrelated to the risk of a government shutdown. As noted earlier, some prior government shutdowns have overlapped with debt limit deadlines, but this has occurred mainly by chance; there is no direct linkage between the two. The debt limit affects the Treasury’s ability to borrow to fund spending that Congress has already approved, while a shutdown occurs if Congress fails to approve spending necessary to keep government operations running.
Q: Doesn’t Congress also need to raise the debt limit?
Yes, probably by October. We estimate that the Treasury might run out of room under the debt ceiling as soon as August but we believe it is more likely that the Treasury will be able to borrow until the September 15 corporate tax deadline, when an inflow of tax receipts will provide a couple of weeks’ worth of additional headroom under the limit. However, we expect that Congress will need to raise the limit by October (Exhibit 1). This projection is very similar to the estimates we published earlier this year.
Exhibit 1: Borrowing capacity under the debt limit likely to be exhausted by October
Source: Treasury Department, Goldman Sachs Global Investment Research
Q: How will the debt limit deadline be resolved?
There has been little discussion of the issue so far, but we can see at least three general approaches Republican leaders might take to address the issue.
First, there is a possibility that it could be raised as part of a must-pass spending bill. For example, spending legislation will need to be enacted by September 30, the end of the current fiscal year.
Second, the reconciliation process can be used to raise the debt limit, in addition to tax changes and certain spending changes. It is possible that Republican leaders might combine tax reform with a debt limit increase, for example. To do so, instructions to increase the debt limit would need to be included in the upcoming FY2018 budget resolution, which we expect to pass in the House and Senate shortly after the health care legislation is finalized, perhaps in May or June.
Third, Republican leaders might choose to pass a debt limit increase as a standalone piece of legislation without any direct linkage to the budget process. Several recent debt limit increases have been passed this way. This option could be attractive if other legislation, like tax reform, is not ready by the time the debt limit needs to be raised.
While we do not expect the debt limit to create the same disruptions in financial markets that it did in 2013 or 2015, it will nevertheless figure into the political agenda for the second half of the year, in our view.