In the latest blow dealt in the US government ‘shutdown’, President Barack Obama has accused the Republican party of blackmail. As the two political parties play tug-of-war over public spending, the threat of a US default looms.
While the Republicans demand spending cuts and ask for changes to the Democrats’ healthcare reforms, the government has entered the second week of ‘shutdown’ – meaning it cannot agree on how to allocate the national budget. As the parties debate, money is running out.
And this negativity is impacting markets: both the Dow Jones and S&P 500 indices have fallen.
Robert Johnson, director of economic analysis for Morningstar, said the key thing he has learned about the U.S. economy over the past several years is that it is like an ocean liner, unable to change course quickly, and steadily maintaining speed and direction.
"The shock needed to shift the economy is a larger than many of us would have guessed just three or four years ago. The U.S economy endured severe storms, volatile gasoline prices, and several government showdowns while hardly skipping a beat," he continued.
The US running out of cash is nothing new - but it does put off plans for tapering quantitative easing, announced in June by Fed Chairman Ben Bernanke.
M&G’s bond manager Jim Leaviss believes the US government shutdown and its economic impact makes tapering in 2013 unlikely.
"The US government shutdown not only has political implications, it also has an economic impact that should not be underestimated," he said. "While government and government agency spending has widely paused, a significant number of government employees are not receiving their salaries while the shutdown goes on."
Leaviss said that the shutdown also dampens economic confidence, which may then affect consumer spending and manufacturing activities in the current and upcoming weeks.
"Although the economic impact from the current government shutdown is difficult to assess, we have seen estimates for a drag on GDP of –0.5% for a 2 week shutdown to -1.4% for a 3-4 week shutdown period," he continued. "Factoring for an already dovish Federal Reserve amid a very low core inflation rate, we think that the government shutdown and its economic impact, particularly the longer it takes, makes tapering in 2013 unlikely and turns it into a story for 2014."
The shutdown could even cause those ratings agencies that have not previously downgraded the US will do so. Bond experts say that this is not likely to have a major impact on Treasury yields however. In 2011 when the S&P downgraded US debt, demand for US government bonds actually increased.
