With the deadline looming for the U.S. government to pass a bill in order to avert a government shutdown, Jeff Weaver, head of Global Liquidity Solutions, and Henri Proutt, portfolio specialist for the Global Liquidity Solutions team, discuss what investors should and should not be concerned about, depending on the result. Jeff and Henri recorded this conversation on November 14, 2023.
Jeff Weaver: As the Fed completes its hiking cycle, we believe risks are favorable for investors seeking even higher returns by extending out the yield curve.
Henri Proutt: That’s Jeff Weaver, head of Global Liquidity Solutions here at Allspring Global Investments. And I’m Henri Proutt, portfolio specialist for the Global Liquidity Solutions team, and you’re listening to On The Trading Desk®. We’re talking about the fast-approaching deadline for the U.S. government to pass a bill in order to avert a government shutdown and what investors should and should not be concerned about, depending on the result. Thanks for being here, Jeff.
Jeff: Thanks, Henri. It’s great to be here.
Henri: The possibility of a government shutdown has been all over the headlines recently. So, let’s start with the basics. What’s a shutdown? And importantly for investors, how does it differ from the debt ceiling debate that we just experienced in May?
Jeff: Thanks, Henri. I’ll start with the latter question because they are distinctively different and it can be confusing for investors. The debt ceiling, which was suspended in early June, limits the government’s ability to borrow. The government has been running at a deficit, so it borrows through the issuance of debt in the form of Treasury bills, notes, and bonds to pay for its operations. When that level of borrowing has encroached upon, it threatens the government’s ability to pay its existing obligations. Leading up to the debt ceiling resolution in June, there was an exaggerated concern that the Treasury could potentially default on upcoming maturities without a resolution. Nonetheless, a debt ceiling resolution was reached and rightfully so. The U.S. government has never failed to pay its obligations and we firmly believe they will not jeopardize the Treasury market standing as the world’s safest, most liquid asset. What we are concerned about today is a potential government shutdown. A U.S. government shutdown occurs when Washington lawmakers fail to pass 12 annual appropriation bills as part of the annual budgeting process. The passage of these bills approves funding for 12 broad departments of the U.S. government. Without this funding, the departments must shut down and nonessential government employees are furloughed. Examples of nonessential government employees are national park rangers. Meanwhile, essential workers, such as air traffic controllers, are not furloughed and must continue to work. Upon a government shutdown resolution, those furloughed can go back to work and are paid retroactively. Government shutdowns, of which there have been 4 in the last 30 years, are generally short lived. The last government shutdown lasted 35 days in December 2018 and January 2019. Where investors will feel impacted is through the lack of economic data, as a government shutdown would likely affect the Bureau of Labor Statistics (BLS). The BLS provides a majority of the data that we as investors analyze, which drives investment decisions and market prices. For example, the all-important employment report that is delivered at the beginning of each month, which includes the changes to the unemployment rate and nonfarm payrolls, is calculated provided by the BLS. Additionally, inflation of course today is very topical. The Consumer Price Index, or CPI, is calculated by the staff at the BLS. And so, in the event of a government shutdown, that data will not be released in a timely manner.
Henri: You said something interesting there. You said, “a timely manner.” So, that data will be released but at a later date?
Jeff: Right. As a general rule, the lag in the data being released will be equal to the time that the BLS employees were furloughed. In that time, investors will depend on data from nongovernmental sources. For example, the Institute for Supply Management, the ISM, is a nonprofit that publishes survey data on both the service and manufacturing industries. That data is heavily relied upon for sentiment, and in the event of a shutdown, emphasis on the data will be even greater. The payroll company ADP also publishes a monthly employment data series. Unfortunately, the ADP report has not been a very useful predictor of the government data.
Henri: I know we on the portfolio management side consider ISM to be tier-one data, if you will. So, it’s good to know that we can still depend on that data series to be an indicator regarding whether the economy is expanding or contracting. In the event that an agreement is not reached, and let’s take a little bit longer of a view now, you spoke about the delay in publishing data by the BLS. The government is our largest employer, which means that’s a lot of workers that will need to be furloughed. Do you have any insight as to what the effect on the overall level of economic activity that might cause?
Jeff: Sure. A prolonged shutdown will certainly have a negative effect on growth given the amount of government workers not being paid. It has been estimated that a shutdown will reduce gross domestic product (GDP) by 0.2% per week, so a five-week shutdown could reduce GDP growth by 1%. Another concern is the United States credit rating. Moody’s just changed its outlook for the United States’ AAA credit rating from stable to negative. This comes after Fitch recently joined S&P by downgrading the U.S. from AAA to high AA. Some of the factors attributed by Moody’s to the negative outlook are ongoing political deadlocks due to political polarization.
Henri: Let’s bring this all back to the bond market and, specifically, the Fed (Federal Reserve).
Jeff: As of today, we don’t expect a change in policy at the December 13 FOMC (Federal Open Market Committee) meeting, particularly following the weaker-than-expected employment report at the beginning of the month and today’s favorable CPI report. At the November 1 FOMC meeting, Chair Powell seemed to downplay their previous expectations that another 25-basis-point increase in the overnight rate would be necessary. And there’s definitely not a consensus view among committee members about whether policy is restrictive enough. Our base case is that the Fed leaves policy unchanged. But if the economy begins to reaccelerate, and we get the sense that prices are increasing again during a time when there is no data to confirm that, it will certainly present quite a challenge for the committee.
Henri: We recently had John Hockers, co-head of Allspring’s Investment Analytics team, on the podcast, and he gave his opinion that a prolonged government shutdown could increase the probability that we see the global economy slip into a recession. Do you have a view on the topic?
Jeff: John and team do great foundational work in highlighting potential risks for us that are tasked with managing money on behalf of clients. As I mentioned previously, a prolonged government shutdown would certainly be a hit to GDP. That said, any decrease in GDP would most likely be offset in the following period as furloughed government workers get back to work and are paid retroactively for their time away.
Henri: With the time we have left today, Jeff, can you share any final thoughts with our listeners about riding the curve in fixed income today?
Jeff: I’ve said this before, Henri, and I’ll say it again, I really like 5%. In fact, it’s possible that investors can earn a yield in excess of 5%, which is greater than the current rate of inflation. And as the Fed completes its hiking cycle, we believe risks are favorable for investors seeking even higher returns by extending out the yield curve.
Henri: Thanks, Jeff, for being with us today and sharing your insights.
Jeff: Thank you, Henri. Pleasure to be here.
Henri: And for our listeners, thank you for joining us here On the Trading Desk®.
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Disclosure: 100 basis points equal 1.00%. The ratings indicated are from Standard & Poor’s, Moody’s Investors Service, and/or Fitch Ratings Ltd. Credit-quality ratings: Credit-quality ratings apply to underlying holdings of the fund and not the fund itself. Standard & Poor’s rates the creditworthiness of bonds from AAA (highest) to D (lowest). Ratings from A to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the rating categories. Moody’s rates the creditworthiness of bonds from Aaa (highest) to C (lowest). Ratings Aa to B may be modified by the addition of a number 1 (highest) to 3 (lowest) to show relative standing within the ratings categories. Fitch rates the creditworthiness of bonds from AAA (highest) to D (lowest). CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.
