Fed Chair Janet Yellen downplayed concerns about the rest of the world and indicated that she was among the majority of Fed officials expected to raise short-term interest rates this year. Meanwhile, while John Boehner’s resignation as House Speaker may signal an agreement on the budget, Congress has moved further away from future compromise.
In the revised dot plot, the graph of senior Fed officials’ forecasts of the appropriate federal funds target rate for the next few years, there is no indication of which dot corresponds to which official. It was speculated that Chair Yellen may have been one of the four officials who didn’t expect to raise short-term interest rates this year. In her post-FOMC press conference, Yellen was obligated to speak for all Fed policymakers. However, in her speech at UMass Amherst, Yellen placed herself among the group expecting a rate hike by year-end. The stock market has often reacted poorly to the possibility of a Fed rate hike. However, investors seemed to be encouraged by Yellen’s expressed confidence in the U.S. economy. Why the Fed would raise rates matters. Yellen downplayed worries about the rest of the world and played up the prospects for the domestic economy.
Real GDP rose at a 3.9% annual rate in the government’s 3rd estimate for 2Q15 (revised from 3.7% in the 2nd estimate). In July, the Bureau of Economic Analysis introduced a new measure: real final sales to private domestic purchasers. This figure is simply GDP less the change in inventories, net exports, and government – a less-volatile measure of underlying domestic demand. Private Domestic Final Sales rose at a 3.9% annual rate in 2Q15, up 3.5% from a year earlier. That’s strong.
One of the key themes in the U.S. economic outlook is the split between the rest of the world and what’s happening at home. Softer global growth and a strong dollar are likely to restrain exports and corporate earnings from abroad. However, falling prices of oil and other commodities should continue to provide support for U.S. consumers and investors. Inventories and foreign trade account for much of the quarter-to-quarter noise in GDP growth and at this point we only have figures for July. However, we should see net exports and slower inventory growth subtracting from GDP growth in 3Q15, perhaps a very large drag on headline growth (which is another good reason to focus on Private Domestic Final Sales).
On Friday, John Boehner announced his resignation as House Speaker effective at the end of October. The only surprise here is the timing. His decision was driven largely by disagreements with the Freedom caucus (a group of ultra-conservative House Republicans) and Tea Party members. Their dissatisfaction with Boehner was largely over his willingness to compromise.
Boehner was blamed for Congress’ inability to overturn the Affordable Care Act. Two years ago, Boehner acquiesced to Tea Party demands to shut the government down. The government does not save money in a shutdown. The 16-day shutdown in 2013 added about $2 billion to the government’s budget shortfall that year (government salaries are still paid, contracts have to be honored, and there are added costs to starting the government up again). It also shaved 0.1 to 0.2 percentage points from GDP growth (mostly activity is shifted from one month to the next). Some private-sector output is lost.
The 2013 shutdown led to a postponement of several economic data releases. It also interfered with the government’s collection of economic data, distorting figures over the following few months.
Boehner’s resignation should significantly reduce the odds of a government shutdown over the budget this week. That was the trade-off. Boehner would work with House Democrats on the budget, but that would cost him his job. At the same time, Boehner’s resignation substantially increases the odds that we’ll see a shutdown over raising the debt ceiling in early December. Boehner’s replacement (the new House Speaker) will be less willing to compromise. The debt ceiling is a much bigger problem than the budget, as it raises the possibility that the Treasury could miss a payment on its debt.
We’ve been through this before. Congress took the Treasury to the brink of default in August 2011. Treasury bill rates briefly spiked higher. Standard & Poor’s downgraded the U.S. credit rating, but that did not have a lasting impact. In fact, Treasury bond yields fell rather than rose.
A government shutdown need not be unsettling for the U.S. economy, but it may add uncertainty for the financial markets. Looking ahead, Washington is expected to become even more dysfunctional that it is now.