Debt-Ceiling Uncertainty Could Fuel Volatility
WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS September 6, 2017
Debt-Ceiling Uncertainty Could Fuel Volatility Craig P. Holke Investment Strategy Analyst Darrell L. Cronk President, Wells Fargo Investment Institute Chief Investment Officer, Wealth and Investment Management
Key Takeaways » Congress must address timely issues in September, including issuing a budget and addressing the debt ceiling. » We believe that Congress will address both of these issues successfully, issuing a continuing resolution to fund the government for 2018 and raising (or suspending) the debt ceiling.
What It May Mean for Investors » Volatility often increases during times of policy uncertainty. We believe that U.S. equity markets may react negatively in the near term, but they could quickly recover if both issues are addressed successfully. The U.S. fixed-income market reaction may vary, with longer-term rates declining but shorter-term rates rising. Congress will have its hands full with all the legislative items that need to be addressed in September. The House of Representatives will only be in session for 12 days during the entire month. Among other items that need to be addressed, there are two significant priorities for congressional leaders: funding the federal government for the next fiscal year to avoid a partial government shutdown—and either raising or suspending the debt ceiling to avoid default. The Basic Steps to Pass a Fiscal-Year 2018 Budget To avoid a government shutdown, Congress must do the following in September: Step #1: Pass an initial budget resolution
Set top-line revenue and expense levels for the 2018 fiscal year that starts on October 1. (Republicans likely will include instructions for tax reform, taking advantage of Senate rules that allow eventual passage with only 51 votes.)
Step #2: Design appropriation bills
The initial resolution instructs congressional committees to produce appropriation bills to fund the federal government for the upcoming fiscal year.
Step #3: Complete the appropriation bills by September 30 or pass a continuing resolution
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 1 of 6
If the process takes longer, a continuing resolution to maintain funding at 1 existing levels will be necessary to avoid a partial government shutdown. If these bills do not pass by September 30 and a continuing resolution is not used, the government will partially shut down, as we experienced in 2013. Along with the differing policy priorities between the parties, the divide between conservative and moderate Republicans has increased to the point that it derailed the repeal of the Affordable Care Act (also known as “Obamacare”). Since Republicans do not have the 60 votes required in the Senate, they will need assistance from Democrats to pass the appropriation bills for the new fiscal year.
Raise the Public Debt Ceiling Separately, Congress will consider raising the current public debt ceiling in September. On July 28, 2017, Treasury Secretary Mnuchin sent a letter notifying Congress that the debt ceiling likely would be breached by the end of September. While the Treasury Department can economize on cash and take other cash-management steps to avoid exceeding the debt limit, these measures eventually will run out. Lawmakers then must raise or suspend the debt ceiling. If the debt ceiling is not raised, the Treasury Department will not be able to issue debt (until it is increased). The government then may try to prioritize payments so it can continue to make debt payments while cutting expenses. Yet, this would most likely be viewed as a default on U.S. debt. If the debt ceiling is not raised in time, or the debate hits a protracted impasse, there is a risk that the U.S. could face a credit-rating downgrade— raising doubts among investors over the federal government’s willingness to pay its debts—and potentially increasing the cost of future borrowing. The parties want to avoid a default, but debt-ceiling debates also have a long history of standoff. Risks do exist that conservative members of Congress will not vote to raise the debt limit without including spending cuts to address the nation’s ever-growing deficits. Yet, these proposed cuts likely would be opposed by Democrats. Because raising the debt ceiling will require 60 votes in the Senate, Republican leadership would then face the dilemma of how to proceed. Will Republican leadership attempt to attract Democrat support with a clean (no spending cuts) debt-ceiling bill? Or, will Republicans seek to avoid a government shutdown by attaching the spending bill to a more popular bipartisan bill? We believe that a clean (no spending cuts) bill is the most likely outcome. Other items with firm deadlines include funding for the Children’s Health Insurance Program (CHIP) and a reauthorization of the Federal Aviation Administration (FAA), both with September 30 deadlines. The National Flood Insurance Program, which is run by the Federal Emergency Management Agency (FEMA), also will run out of funding at the end of September. With the devastation of Hurricane Harvey, this will be a highprofile funding vote. Table 1 highlights the key issues, what to expect and the associated risks for these funding initiatives (including the debt ceiling and federal appropriations). 1 A partial shutdown would entail “nonessential government services” (e.g. the Food and Drug Administration, Environmental Protection Agency, National Park System, etc.) to temporarily stop, while those services deemed essential (e.g. national defense, air traffic control, law enforcement, etc.) would continue as normal. The U.S. Treasury Department also would remain operational, continuing to collect taxes and issue debt. © 2017 Wells Fargo Investment Institute. All rights reserved. Page 2 of 6
Table 1: Key Policy Issues, Dates and Likely Outcomes Expected Date or Time Frame
What Must Happen
September 29
Raise the debt ceiling
September 30
Key Risks
What We Expect
Conservative Republicans may The debt ceiling will be raised as push for spending cuts, but no a clean bill with no strings one wants to risk default. attached.
Conflicting interests between Congress probably won’t finish Federal appropriations bill deadline for Republicans, Democrats and the in time. We expect a continuing fiscal year 2018 White House could threaten a resolution. U.S. government shutdown.
September 30
Funding for other programs (CHIP, NFIP, FAA, etc.)
Consumes time required for addressing more pressing issues.
Funding will be approved, but may include policy changes.
November / December
This is the target time frame for tax reform or tax cuts (based upon recent statements from the U.S. Treasury).
The time frame may be too aggressive. This effort may extend into the first quarter of 2018.
We do expect a package of tax reform and/or tax cuts, but it likely will be smaller than many originally anticipated.
Source: Wells Fargo Investment Institute, 9/1/17
Although much work has been going on behind the scenes, the budget resolution must be approved before bipartisan tax-reform negotiations begin. Tax reform is a key platform item for Republicans, but the deadlines for raising the debt ceiling and passing a spending bill likely will push significant progress on tax reform (or cuts) into the fourth quarter. Investment Implications The number of items for Congress to complete in September increases political uncertainty and, ultimately, economic uncertainty. At times, the tone of political dialogue in the U.S. today can serve to make markets more volatile, rather than offering certainty and direction. Political discord has been front and center in recent quarters, and President Trump has strong views on matters that could impact the spending and debt-ceiling resolution. As a result, we do believe that an increase in near-term market volatility is likely to occur as the late-September deadlines approach. Although Republicans control both houses of Congress and the White House, needing 60 votes in the Senate could make passage of appropriation bills difficult. Yet, we believe that the most likely path for budget negotiations will be the use of a continuing resolution. In the event of a government shutdown, however, history shows that U.S. equity-market volatility typically increases in the run-up to the deadline—yet the market historically has recovered quickly. While previous shutdowns had no lasting impact, longer shutdowns have extended market recovery times. Fixed-income markets also have faced limited, short-term reactions from government shutdowns. Due to the term structure of government debt, the main concern for investors involves securities that mature on dates that are near the debt-ceiling (or appropriations) deadline, or that mature during the shutdown. In the past, however, these have all been paid at maturity with no defaults taking place.
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 3 of 6
Failure to address the debt ceiling is a much less likely outcome than a government shutdown due to failure to pass a spending bill before October 1. Yet, the debt-ceiling resolution has much greater implications for the economy and markets. No party wants to be responsible for a potential default on U.S. government debt. Thus, as noted, we believe that the most likely solution is the passage of a clean debt-ceiling bill that either increases or suspends the debt ceiling. As with other times of policy uncertainty (e.g., government shutdowns), market volatility is expected to increase. U.S. equity markets have tended to react negatively in the near term— and then recover as policy issues are resolved. During debt-ceiling negotiations in 2011, longer-term U.S. interest rates declined in advance of the deadline, but increased afterward to end the year at levels near where they started. Congress will be very busy in September. The shortened time in session, combined with the number of items being addressed, will pressure both parties to work together to resolve the debt-ceiling and budget issues. While we ultimately believe that these issues will be resolved, failure to successfully address either of these situations likely will detract from Republicans’ ability to enact meaningful tax reform or cuts. We encourage investors to remain broadly (and globally) diversified across asset classes, and to continue to follow their investment plans.
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 4 of 6
Economic Calendar
Date
Report
Estimate
Previous
9/5/2017
Factory Orders
-3.20%
3.00%
9/5/2017
Factory Orders Ex Trans
--
-0.20%
9/5/2017
Durable Goods Orders
1.00%
-6.80%
9/5/2017
Durables Ex Transportation
--
0.50%
9/5/2017
Cap Goods Orders Nondef Ex Air
--
0.40%
9/5/2017
Cap Goods Ship Nondef Ex Air
--
1.00%
9/6/2017
MBA Mortgage Applications
--
-2.30%
9/6/2017
Trade Balance
-$44.6b
-$43.6b
9/6/2017
Markit US Services PMI
56.9
56.9
9/6/2017
Markit US Composite PMI
--
56
9/6/2017
ISM Non-Manf. Composite
55.3
53.9
9/6/2017
U.S. Federal Reserve Releases Beige Book
9/7/2017
Initial Jobless Claims
244k
236k
9/7/2017
Nonfarm Productivity
1.20%
0.90%
9/7/2017
Continuing Claims
1945k
1942k
9/7/2017
Unit Labor Costs
0.40%
0.60%
9/7/2017
Bloomberg Consumer Comfort
--
53.3
9/8/2017
Wholesale Inventories MoM
0.40%
0.40%
9/8/2017
Wholesale Trade Sales MoM
--
0.70%
9/8/2017
Consumer Credit
$15.350b
$12.397b
Source: Bloomberg as of 9/1/17
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 5 of 6
Risks Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.
General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 0917-00328
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 6 of 6
Debt-Ceiling Uncertainty Could Fuel Volatility Craig P. Holke Investment Strategy Analyst Darrell L. Cronk President, Wells Fargo Investment Institute Chief Investment Officer, Wealth and Investment Management
Key Takeaways » Congress must address timely issues in September, including issuing a budget and addressing the debt ceiling. » We believe that Congress will address both of these issues successfully, issuing a continuing resolution to fund the government for 2018 and raising (or suspending) the debt ceiling.
What It May Mean for Investors » Volatility often increases during times of policy uncertainty. We believe that U.S. equity markets may react negatively in the near term, but they could quickly recover if both issues are addressed successfully. The U.S. fixed-income market reaction may vary, with longer-term rates declining but shorter-term rates rising. Congress will have its hands full with all the legislative items that need to be addressed in September. The House of Representatives will only be in session for 12 days during the entire month. Among other items that need to be addressed, there are two significant priorities for congressional leaders: funding the federal government for the next fiscal year to avoid a partial government shutdown—and either raising or suspending the debt ceiling to avoid default. The Basic Steps to Pass a Fiscal-Year 2018 Budget To avoid a government shutdown, Congress must do the following in September: Step #1: Pass an initial budget resolution
Set top-line revenue and expense levels for the 2018 fiscal year that starts on October 1. (Republicans likely will include instructions for tax reform, taking advantage of Senate rules that allow eventual passage with only 51 votes.)
Step #2: Design appropriation bills
The initial resolution instructs congressional committees to produce appropriation bills to fund the federal government for the upcoming fiscal year.
Step #3: Complete the appropriation bills by September 30 or pass a continuing resolution
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 1 of 6
If the process takes longer, a continuing resolution to maintain funding at 1 existing levels will be necessary to avoid a partial government shutdown. If these bills do not pass by September 30 and a continuing resolution is not used, the government will partially shut down, as we experienced in 2013. Along with the differing policy priorities between the parties, the divide between conservative and moderate Republicans has increased to the point that it derailed the repeal of the Affordable Care Act (also known as “Obamacare”). Since Republicans do not have the 60 votes required in the Senate, they will need assistance from Democrats to pass the appropriation bills for the new fiscal year.
Raise the Public Debt Ceiling Separately, Congress will consider raising the current public debt ceiling in September. On July 28, 2017, Treasury Secretary Mnuchin sent a letter notifying Congress that the debt ceiling likely would be breached by the end of September. While the Treasury Department can economize on cash and take other cash-management steps to avoid exceeding the debt limit, these measures eventually will run out. Lawmakers then must raise or suspend the debt ceiling. If the debt ceiling is not raised, the Treasury Department will not be able to issue debt (until it is increased). The government then may try to prioritize payments so it can continue to make debt payments while cutting expenses. Yet, this would most likely be viewed as a default on U.S. debt. If the debt ceiling is not raised in time, or the debate hits a protracted impasse, there is a risk that the U.S. could face a credit-rating downgrade— raising doubts among investors over the federal government’s willingness to pay its debts—and potentially increasing the cost of future borrowing. The parties want to avoid a default, but debt-ceiling debates also have a long history of standoff. Risks do exist that conservative members of Congress will not vote to raise the debt limit without including spending cuts to address the nation’s ever-growing deficits. Yet, these proposed cuts likely would be opposed by Democrats. Because raising the debt ceiling will require 60 votes in the Senate, Republican leadership would then face the dilemma of how to proceed. Will Republican leadership attempt to attract Democrat support with a clean (no spending cuts) debt-ceiling bill? Or, will Republicans seek to avoid a government shutdown by attaching the spending bill to a more popular bipartisan bill? We believe that a clean (no spending cuts) bill is the most likely outcome. Other items with firm deadlines include funding for the Children’s Health Insurance Program (CHIP) and a reauthorization of the Federal Aviation Administration (FAA), both with September 30 deadlines. The National Flood Insurance Program, which is run by the Federal Emergency Management Agency (FEMA), also will run out of funding at the end of September. With the devastation of Hurricane Harvey, this will be a highprofile funding vote. Table 1 highlights the key issues, what to expect and the associated risks for these funding initiatives (including the debt ceiling and federal appropriations). 1 A partial shutdown would entail “nonessential government services” (e.g. the Food and Drug Administration, Environmental Protection Agency, National Park System, etc.) to temporarily stop, while those services deemed essential (e.g. national defense, air traffic control, law enforcement, etc.) would continue as normal. The U.S. Treasury Department also would remain operational, continuing to collect taxes and issue debt. © 2017 Wells Fargo Investment Institute. All rights reserved. Page 2 of 6
Table 1: Key Policy Issues, Dates and Likely Outcomes Expected Date or Time Frame
What Must Happen
September 29
Raise the debt ceiling
September 30
Key Risks
What We Expect
Conservative Republicans may The debt ceiling will be raised as push for spending cuts, but no a clean bill with no strings one wants to risk default. attached.
Conflicting interests between Congress probably won’t finish Federal appropriations bill deadline for Republicans, Democrats and the in time. We expect a continuing fiscal year 2018 White House could threaten a resolution. U.S. government shutdown.
September 30
Funding for other programs (CHIP, NFIP, FAA, etc.)
Consumes time required for addressing more pressing issues.
Funding will be approved, but may include policy changes.
November / December
This is the target time frame for tax reform or tax cuts (based upon recent statements from the U.S. Treasury).
The time frame may be too aggressive. This effort may extend into the first quarter of 2018.
We do expect a package of tax reform and/or tax cuts, but it likely will be smaller than many originally anticipated.
Source: Wells Fargo Investment Institute, 9/1/17
Although much work has been going on behind the scenes, the budget resolution must be approved before bipartisan tax-reform negotiations begin. Tax reform is a key platform item for Republicans, but the deadlines for raising the debt ceiling and passing a spending bill likely will push significant progress on tax reform (or cuts) into the fourth quarter. Investment Implications The number of items for Congress to complete in September increases political uncertainty and, ultimately, economic uncertainty. At times, the tone of political dialogue in the U.S. today can serve to make markets more volatile, rather than offering certainty and direction. Political discord has been front and center in recent quarters, and President Trump has strong views on matters that could impact the spending and debt-ceiling resolution. As a result, we do believe that an increase in near-term market volatility is likely to occur as the late-September deadlines approach. Although Republicans control both houses of Congress and the White House, needing 60 votes in the Senate could make passage of appropriation bills difficult. Yet, we believe that the most likely path for budget negotiations will be the use of a continuing resolution. In the event of a government shutdown, however, history shows that U.S. equity-market volatility typically increases in the run-up to the deadline—yet the market historically has recovered quickly. While previous shutdowns had no lasting impact, longer shutdowns have extended market recovery times. Fixed-income markets also have faced limited, short-term reactions from government shutdowns. Due to the term structure of government debt, the main concern for investors involves securities that mature on dates that are near the debt-ceiling (or appropriations) deadline, or that mature during the shutdown. In the past, however, these have all been paid at maturity with no defaults taking place.
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 3 of 6
Failure to address the debt ceiling is a much less likely outcome than a government shutdown due to failure to pass a spending bill before October 1. Yet, the debt-ceiling resolution has much greater implications for the economy and markets. No party wants to be responsible for a potential default on U.S. government debt. Thus, as noted, we believe that the most likely solution is the passage of a clean debt-ceiling bill that either increases or suspends the debt ceiling. As with other times of policy uncertainty (e.g., government shutdowns), market volatility is expected to increase. U.S. equity markets have tended to react negatively in the near term— and then recover as policy issues are resolved. During debt-ceiling negotiations in 2011, longer-term U.S. interest rates declined in advance of the deadline, but increased afterward to end the year at levels near where they started. Congress will be very busy in September. The shortened time in session, combined with the number of items being addressed, will pressure both parties to work together to resolve the debt-ceiling and budget issues. While we ultimately believe that these issues will be resolved, failure to successfully address either of these situations likely will detract from Republicans’ ability to enact meaningful tax reform or cuts. We encourage investors to remain broadly (and globally) diversified across asset classes, and to continue to follow their investment plans.
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 4 of 6
Economic Calendar
Date
Report
Estimate
Previous
9/5/2017
Factory Orders
-3.20%
3.00%
9/5/2017
Factory Orders Ex Trans
--
-0.20%
9/5/2017
Durable Goods Orders
1.00%
-6.80%
9/5/2017
Durables Ex Transportation
--
0.50%
9/5/2017
Cap Goods Orders Nondef Ex Air
--
0.40%
9/5/2017
Cap Goods Ship Nondef Ex Air
--
1.00%
9/6/2017
MBA Mortgage Applications
--
-2.30%
9/6/2017
Trade Balance
-$44.6b
-$43.6b
9/6/2017
Markit US Services PMI
56.9
56.9
9/6/2017
Markit US Composite PMI
--
56
9/6/2017
ISM Non-Manf. Composite
55.3
53.9
9/6/2017
U.S. Federal Reserve Releases Beige Book
9/7/2017
Initial Jobless Claims
244k
236k
9/7/2017
Nonfarm Productivity
1.20%
0.90%
9/7/2017
Continuing Claims
1945k
1942k
9/7/2017
Unit Labor Costs
0.40%
0.60%
9/7/2017
Bloomberg Consumer Comfort
--
53.3
9/8/2017
Wholesale Inventories MoM
0.40%
0.40%
9/8/2017
Wholesale Trade Sales MoM
--
0.70%
9/8/2017
Consumer Credit
$15.350b
$12.397b
Source: Bloomberg as of 9/1/17
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 5 of 6
Risks Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.
General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 0917-00328
© 2017 Wells Fargo Investment Institute. All rights reserved.
Page 6 of 6
