Shutdown fears seemed to have shutdown on Wednesday evening when lawmakersallegedly found the contours of a deal to fund the government through the end of FY 2011.
Unsurprisingly, John Boehner on Thursday says no deal is imminent. The proposed details are still worth glancing at, however, as the rough size of any final package now seems a bit clearer.
According to the Washington Post, the White House and Congress are narrowing in on a further $23bn worth of spending cuts in FY 2011, in addition to the $10bn agreed on March 15. (NB that there are different baselines for these cuts; we’re using the FY2010 funding rather than the President’s budget request.)
An aggregate reduction of $33bn would be approximately midway between House Republicans’ initial proposal for $61bn of cuts and Senate Democrats’ call for as few reductions as possible.
There’s still a lot of negotiating to do on the contents of the package before the April 8 deadline, with Republicans keen to attach so-called “riders” that restrict the functions of certain federal agencies. We’ll look out for any read-across to Dodd-Frank implementation by regulatory agencies.
But as we’ve pointed out before, the FY 2011 Budget negotiations are mere pre-season training before the real games begin: the debate over the debt ceiling (the US treasury is due to hit the limit sometime after April 15, though this could be revised soon) and the FY2012 budget.
A couple of points, though, on the shutdown shakedown. Firstly, on the politics, John Boehner is showing short-term political nous, exploiting the Tea Party to get a decent result for Congressional Republicans. But this could have repercussions in 2012 if his right-wing feels slighted. Insert your battle-war metaphor here.
Secondly, on the economics, expect a few job cut estimates from analysts that are in the low hundreds of thousands. Ben Bernanke reckoned that the $61bn package put “a couple of hundred thousand jobs” at stake. We think it’s important to separate when the money is spent (“outlays”) from the face value figures, but the truth is that we just don’t know the impact yet.
Ezra Klein was worried, too, about the impact of any shutdown on Treasury yields and government borrowing costs. He cites an interesting paper that looks at the long-term effect of state budget shutdowns on 20-year GO bond yields. The headline:
“We estimate that a budget delay of 30 days has a long run impact on the yield spread [DN: vs NJ GO bonds] between 2 and 10 basis points,”
As Klein pointed out, the analogy with the current UST market is far from perfect. There’s a lot of variation within the sample of states used in the paper, making it hard to draw too many conclusions.
Let’s not forget also that the mere run-up to the debt ceiling could impact the Treasuries market. We are in a different world from 1995-6 when, as this primerfrom LPL Financial Research points out, Moody’s “only” put $387bn of short-term issuance under credit watch negative and yields remained “relatively stable”.
As we’ve explained, there are many special tricks the Treasury can perform to stay below the limit for as long as possible. But as a paper we’ve referenced before from the GAO points out, these and the general uncertainty for bond investors can impair the Treasuries market, particularly in short-term notes.
Market participants that we spoke with said that any actions that Treasury takes to manage debt as it approaches the limit that cause Treasury to deviate from its otherwise regular and predictable schedule or reduce liquidity introduce uncertainty into the Treasury market and have the potential to increase Treasury’s borrowing costs.
Based on one estimate that assumes that the rate on the note would have been roughly equal to the constant maturity rate, or the closing rate on actively traded Treasury securities maturing at the same time on the day that the auction actually took place, Treasury paid an additional 7 basis points—or 0.07 percentage points—on the $27 billion in 2-year notes issued that day. Based on an alternative estimate that assumes that Treasury would have received the prevailing interest rate on 2-year notes in the secondary market on the day that the auction was originally scheduled to take place, the increased interest costs would be even greater.
It adds that the effect is larger when the Treasury gives little warning of auction postponements and when this takes place beyond the maturity date of previously issued securities.
The overall effect should be kept in context, but according to the GAO “significant” yet minor disruptions have taken place previously.
The impact of actually reaching the limit is of course another issue all together…
Related link:Chancing on the (debt) ceiling – FT Alphaville
Meanwhile, in Washington… – FT Alphaville
Meanwhile, in Washington… – FT Alphaville
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