Having been quite confident that Trump would be able to pass some form of Tax reform as recently as two weeks ago, Goldman’s Washington analyst, Alec Phillips, is turning increasingly more pessimistic on the prospects that Trump’s economic agenda will gain traction in Congress, especially now that attention has seemingly shifted to Trump’s bombing policies in Syria (and perhaps North Korea in the not too distant future).

In a note over the weekend, the Goldman strategist writes that “following the failure to pass the American Health Care Act (AHCA), which would repeal the Medicaid expansion and tax hikes enacted in the Affordable Care Act (ACA) and reduce the tax subsidies for health insurance under that law, Republican leaders in the House have struggled to develop an alternative health proposal that might find enough support to pass. At this point, it still appears possible that the House could pass a revised version of the bill at some point in May. However, the compromises that might be made in the House to gain support are apt to reduce support in the Senate, and the process in that chamber would take much longer than even the drawn out House process, in our view.”

He also observes that lawmakers and market participants have refocused their attention on tax reform, “though a number of other issues are likely to delay activity on tax legislation for another several weeks.” This includes another potential attempt to pass health legislation, the possibility of a government shutdown, a debt limit deadline later this year, and geopolitical developments.

Which brings us to the key topc: the prospect of a government shutdown in less than three weeks. This is what Phillips says when discussing the risks of a government shutdown on April 29.

Congressional appropriations expire April 28. If Congress does not pass an extension, the federal government will partially shut down. The economic consequences of a short shutdown are minor, since lost federal pay is usually made up retroactively and government procurement and private sector activity would be largely unaffected.

 

However, a shutdown would send  another signal to markets that Republicans may not be able to enact their agenda, lowering expectations for tax reform and an infrastructure program.

We believe Congress is more likely to meet the deadline, but see a one in three chance of a shutdown.

 

The “freedom caucus” in the House may be unwilling to vote for a spending bill, denying Republicans a majority without Democratic votes. However, Democrats might be unwilling to provide those votes as they often have in the past, in light of the decision to change Senate rules to confirm Neil Gorsuch to the Supreme Court over Democratic opposition.

 

That said, there is not yet a clear issue Democrats are likely to point to in defense of a shutdown, as Republicans did in the 2013 shutdown when they demanded that Obamacare be defunded. If such an issue emerges—Republican leaders have already indicated they plan to keep funding for the border wall out of the bill to avoid such an issue—then the odds of a shutdown would rise considerably.

Amusingly, Goldman observes that Trump’s escalation of the Syrian conflict may actually be a positive factor, reducing the odds of a shutdown.

We also note that a shutdown might be slightly less likely in light of the conflict with Syria, since a failure to extend spending authority would affect the Department of Defense in addition to domestic agencies, and some lawmakers might support the spending bill for that reason.

So now that even Goldman admits that the odds of a government shutdown are rising (two weeks ago Deutsche Bank calculated that government shutdown odds had risen to a roughly similar 40%), here is what readers “need to know” about the threat of a potential government shutdown according to Bloomberg:

• As Congress works to fund the government for the second half of FY2017, investors are weighing the possibility of a partial government shutdown if lawmakers fail to reach an agreement by April 28.
• President Trump has asked for about $30b in emergency spending for defense, along with $18b in cuts to non-defense spending
• Oklahoma Rep. Tom Cole said appropriations will ignore the $18b in cuts as they negotiate the omnibus bill and a supplemental
• Gridlock in Washington could slow pro-business reforms so much that markets would “effectively price them out,” BMO strategists Ian Lyngen and Aaron Kohli wrote March 28; they said a government shutdown would be bullish for USTs, risk- off assets

HOW LONG DOES CONGRESS HAVE TO COME TO A DEAL?

• The second continuing resolution for the FY2017 budget expires April 28; Congress needs to pass a spending bill or continuing resolution (CR) to fund the government for the second half of the FY
• Congress passed the first CR Sept. 28, which extended funding at previous year’s levels through Dec. 9. Congress is in recess starting this week and returns the week of April 24, leaving just 4 days to cobble a deal.

WHAT HAPPENS IF THEY DON’T?

• A (partial) government shutdown along lines of 2013; federal government workers are furloughed if their agency is part of the annual appropriations process, according to the U.S. Office of Personnel Management
• During the 2013 shutdown, some government economic data releases were postponed and rescheduled
• The October jobs report was delayed until Nov. 8 due to the 16-day impasse in 2013. The report was originally slated for Nov. 1
• The Fed, which isn’t funded via congressional appropriations, released meeting minutes as scheduled during the 2013 shutdown

WHAT ABOUT THE DEBT CEILING?

• Debt ceiling is a non-issue; since Treasury reinstated the debt limit on March 15, it has employed extraordinary measures to extend its borrowing authority through September/October
• In 2013, the debt ceiling drop-dead date coincided with the shutdown, which created more uncertainty

HOW WILL MARKETS REACT?

• TD strategists led by Priya Misra suggest a government shutdown may be negative for risk assets as it’s likely markets would price in lower odds of tax reforms being enacted in 2017
• In September 2013, equities dropped heading into the shutdown, then rose when a resolution appeared imminent.
• Spending negotiations “may bring continued volatility,” but unlikely to drive UST gains as odds of a shutdown are low, JPMorgan strategists led by Jay Barry said in March 29 note.
• 10Y yields fell by about 37bps to 2.62% in the month leading up to the 2013 shutdown, then rose to 2.73% by Oct. 15.
• Treasury bills may react more to cut in seasonal supply after the tax deadline, not the shutdown, Nomura strategists led by George Goncalves said March 31
• Rates on 1-month securities surged to 0.36%, then the highest levels since the financial crisis.

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