The shutdown and the economy

The US federal government impasse is clearly having a material impact on the economy.  The impact is both direct - from government employees and many companies that do business with the federal government -  and indirect from the hit to the American consumer and consumer spending. Here is part what the direct impact looks like:

Yahoo/Finance: - If there was any confusion about what part of the economy is working and what part is broken, the political antics of the last week have definitively cleared that up.

The shutdown of the federal government represents both a direct setback for the economy and a symbolic arrow pointing to one of the economy’s weakest sectors. Economic forecasting firm IHS Global Insight estimates that every week the government remains shuttered will reduce GDP by $1.6 billion. That's not a huge hit in the grand scheme of things, but the economy is weak to start with, and it’s not usually considered prudent to trip a limping patient.

The furlough of as many as 800,000 federal employees—punctuated by the government’s failure to publish the monthly jobs report for September on schedule, due to the shutdown--will further weaken a sector that’s already detracting from employment.

The indirect impact on the other hand is harder to quantify, but if the situation is not resolved soon, it will overshadow the direct impact. One can already see what the sutdown is doing to consumer confidence from some high frequency sentiment surveys. The Gallup Economic Confidence Index for example is at the lowest level in over a year. 

Those who believe that the politicians responsible for this madness are trying to help US households and small businesses should just look at the chart below.

Source: Gallup

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Q3 M&A deal volume worst since 2009

Except for a few high profile mega-deals, such as Dell and Verizon Wireless, mergers and acquisitions volume remains light both in the US and globally. In particular private equity buyout activity has been weak and declining. That's one of the reasons corporate loan supply remains tight (see discussion).

Source: Mergermarket

Of particular concern is the Q3 slowdown in deals. It's driven by the uncertainty created through Fed's "taper talk" as well as the dysfunctional behavior of the US federal government.

TheStreet: - Deal volumes for the third quarter sank to their lowest levels in three years as a lack of corporate confidence on the economic outlook continues to erode M&A appetite.

There were just 2,235 deals announced in the third quarter, the worst since the same period in 2009, according to Dealogic, as uncertainty caused by the government shutdown, an end to Federal Reserve stimulus and a raft of new capital and regulatory requirements bite.

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HY spreads now positively correlated to treasury yields

Here is further evidence that in this environment treasuries are driving "risk asset" valuations. Corporate HY bond spreads are now positively correlated to treasury yields. That's quite unusual because traditionally when treasury yields shrink, spreads rise (negative correlation).

Based on Merrill HY Index

By not allowing treasury yields to rise, the Fed is artificially suppressing HY spreads (as well as other "risky" bond spreads). The corporate market is therefore heavily dependent on stimulus, making any attempt to normalize monetary policy increasingly difficult.

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Market beginning to price in the risk of US technical default

We've seen this movie in 2011. Washington's inability to raise the debt ceiling could make the current government shutdown look like child's play. Yet just as before, the saber rattling is on.

FoxNews: - Some Republicans want to use the debt-ceiling vote to extract additional concessions, much of which pertain to cutting spending.

"I'm not going to raise the debt ceiling yet again without addressing why we're in debt," Sen. Lindsey Graham, R-S.C., told Fox News. He and other Republicans argue that these spending cuts are critical in order to bring the federal budget back to a sustainable level and, ultimately, start to reverse the seemingly inexorable rise of the national debt.

Some Republicans, though, also want to use the debt-ceiling vote to extract concessions over ObamaCare. From their standpoint, it's for the good of the economy.

Rep. Ted Poe, R-Texas, like many of his colleagues, said the overwhelming message he hears from business owners is their dislike of Obama's health care overhaul, which is at the center of Congress' impasse and the government shutdown. Likewise, Rep. Steve Chabot, R-Ohio, said he mostly hears business owners complain "about the negative effects of `Obamacare' upon their ability to do business and hire people."

Hopefully Rep. Chabot understands that any negative effects of Obamacare on business owners (discussed here) will be dwarfed by the global chaos created from the US government's inability to borrow. You don't solve the US deficit problem by threatening a technical default.

Just as in 2011, with the US debt ceiling date approaching, longer dated treasury yields have moved lower. What the media tends to miss however is that the short end of the curve is doing the opposite. The yield on one-month bills has increased. That's because most investors think the technical default will result in merely a short-term delay in payments by the US Treasury. Which means that the one-month bill holders may not get their principal back on time - causing the 1m bill yields to rise. A delay in longer maturity securities is not as critical to pricing. But yields on other T-bills will also rise if the expected delay in payments extends beyond a few days.

The expectation of any default being simply a delay of payments doesn't mean one could take this situation lightly. Even a delay in repaying the one-month bill will send shock waves through the global markets. It could even endanger the functioning of various banking payment systems that rely on predictable treasury payments.

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Additional confirmation of flawed jobless claims reports

We now have further confirmation that the Department of Labor recent reports on jobless claims have been flawed (see post). The sudden drop in initial claims (below) should correspond to an outsize jump in new jobs created last month.

However, today's report from ADP shows that the September nonfarm private payroll growth was not materially different from that in August or July. And it is highly unlikely that we've had a sudden increase in new government jobs last month. It's time for the U.S. Bureau of Labor Statistics to do a recount of the unemployment claims - once they are back in the office of course.

Source: ADP

Update: Gallup is also not showing any significant improvements in US labor markets during September.

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Commodities under pressure again

The rally in commodities, which started in August has petered out. Several major commodities indices show significant declines on a year-over-year basis.

CRB BLS Spot Cash (commodity) Index (source: Barchart)

Dow Jones UBS Commodity Index

There are several reasons prices have turned lower again:

1. The government shutdown certainly is not helping - if anything, just due to slower expected economic activity.
2. With the Syria strike seemingly off the table for now and new hopes for a better relationship with Iran, energy prices have stabilized.
3. A number of emerging market nations are still reeling from recent capital outflows, weak currencies, and tighter monetary conditions. This is expected to cap demand for raw materials and energy.
4. While the Fed chose to keep up the securities purchases, taper is only a matter of time. And that is also a negative for commodities.
5. There seems to be a commodity fund that was forced to liquidate positions - which is adding to the pressure across various commodity sectors.

Reuters: - Prices for gold, copper, crude oil and a number of other commodities fell on Tuesday after the U.S. government's partial shutdown caused investors to sell and discouraged others from buying.

In addition, talk circulated that a commodities fund was having to liquidate positions.

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Is the anti-ObamaCare campaign hurting the Republicans?

The Rasmussen daily survey (chart below) seems to indicate that the government closure may in fact be helping the Obama administration's approval ratings, while potentially hurting the Republican Party. If the trend continues, the shutdown is unlikely to persist for too long. Here is an interesting take on the subject from The Week.

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US CDS widens as shutdown looms

The US sovereign CDS spread has risen in the past couple days with the government shutdown becoming more real.

Source: DB

But it's not the shutdown itself that's driving the US default probability higher. It's the fact that the shutdown sets a precedent for the upcoming debt ceiling debate (see video below). US politicians are showing willingness to "play chicken" and they may do it again when it comes to the debt ceiling decision (in mid October). But unlike the shutdown, the inability to raise the debt ceiling could result in a payment default (in addition to a slew of other nasty consequences). While the probability of such an event is quite low, it's enough to widen the CDS spread.

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