The past few years have been marked by partisan budget debates that often made investors—and the markets—nervous. But that seems to be over with for the time being.
The most pressing budget issues have been resolved. The debt limit was recently suspended through March 15, 2015, and a bipartisan budget deal for fiscal years 2014 and 2015 was passed in December. We checked with three of our experts to see what that may mean for investors.
The past few years have been marked by partisan budget debates that created a lot of uncertainty for investors. I think this year will be different, because Congress has taken the most pressing budget issues off the table. The debt limit has been suspended through the middle of next March, and a bipartisan deal on federal spending greatly minimizes the risk of a government shutdown before September 2015. These budget agreements are a stark contrast to the polarization and gridlock that led to a 16-day government shutdown last fall. It's a sure sign that Republicans and Democrats both have budget fatigue, and neither side wants to battle budget issues as they head into the November elections.
After so many high-drama budget battles and last-minute deals, the quick resolution to this year’s budget issues shows how much the budget environment has changed. In 2011, concern over historically high deficits allowed Republicans to secure more than $2 trillion of spending cuts in exchange for raising the debt limit that summer. However, a lot of the low-hanging fruit is now gone—meaningful spending cuts would require entitlement reform, which is a non-starter in the Senate. In addition, the fiscal cliff deal in 2012 allowed some tax cuts to expire. The combination of higher tax revenue and lower spending has helped put a big dent in the deficit, so there is less urgency around further budget austerity—at least for now.
Like a ship passing in the night, the debt-ceiling deadline came and went with little fanfare or financial market repercussions. And Washington policymakers did not use the threat of default as a bargaining tool, or even mention it as a potential option.
Short-term Treasury bills did see a slight increase in rates two weeks prior to the February 7 debt-ceiling deadline, but the cutoff date barely created a blip on most investors’ radar screens—unlike October 2013 or August 2011. Instead, investors focused on equity market volatility created by stresses in emerging-market countries, and interest-rate movement resulting from weaker-than-expected economic data releases.
I think the financial market volatility and international investor angst resulting from the threat of a default, as well as the decision to shut down of the federal government in October 2013, helped lawmakers take a more measured tone.
While U.S. fiscal challenges are not permanently resolved, the passage of another debt ceiling deadline underscores the trend that fiscal policy risk continues to fade as a driver of market or macroeconomic concerns. The near-term budget outlook continues to improve, with the deficit projected to decline below 3% of GDP in 2014. Budget cuts and tax increases are a much smaller drag on economic growth this year than last. And policymakers appear to have lost their appetite for deadline brinkmanship, at least for the time being. As a result, we have greater policy clarity and a more favorable fiscal climate for 2014 than at any point in the past few years. That should allow the markets to focus less on Washington and more on the steady trends in the U.S. economy, and on corporate earnings.
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