Economic Outlook, Nov 16th

Government Shutdown

• On November 14th, the House, defying expectations, approved a crucial stopgap bill to prevent the forthcoming government shutdown, achieving the necessary two-thirds majority. The bill proposed by the House Speaker Mike Johnson, introduces a unique dual-deadline strategy, allocating temporary funding until January 19th for essential areas like military construction, veterans' affairs, and transportation, with an extension for other government functions until February 2nd. This “strategic” move, omits additional support for Israel and Ukraine, is designed to avoid the traditional rush of extensive spending legislation typically observed before the holiday season. Despite facing opposition from conservatives for not passing significant spending cuts, the bill, now with a Democrat-majority Senate, is expected to pass effortlessly, signaling a pivotal moment in managing the nation’s budget.

 
Budget deficit

• The current budget deficit is 5% of the GDP, implying government spending currently exceeds revenue coming in. In addition, 65% of the federal budget is indexed to inflation, which indicates that fluctuating inflation rates can make it difficult to forecast future budget requirements. The percentages are influenced by a mix of economic, demographic, political, and social factors. It is a significant indicator of how the government balances the need to maintain the real value of its spending, especially on social welfare, against other fiscal and economic considerations. With social welfare rising and with a trajectory for social security to be depleted by 2033, unless benefits and taxes are restructured, an increasing portion of the budget dedicated to mandatory spending, there might be less flexibility for other areas of spending. Hence, high, and rising debt will increase interest rates, reduce incomes, crowd out private investment, and diminish growth. It also increases the risk of a sudden fiscal crisis where bond holders lose confidence in the government’s ability or willingness to service debt, without inflating away the debt’s value by reducing the purchasing power of the U.S. dollar. Concerns about debt sustainability can lead to increased volatility in bond markets which investors will opt out of causing the gap of deficit to widen. In addition, this can also affect the value of the dollar. A weaker dollar (depreciation) can make imports more expensive, contributing to inflation, and can create volatility in currency markets.
• Recently, Moody's became the final one among the big three credit rating agencies, including S&P and Fitch, to downgrade U.S. debt from stable to negative. This action reflects concerns about substantial fiscal deficits and worsening debt affordability. Earlier, Fitch had revised its rating from AAA to AA+ in August, aligning with S&P's AA+ rating that has been in place since 2011. Christopher Hodge, Natixis's chief U.S. economist, emphasized the ongoing challenge, noting, "Deficits will remain large ... and as interest costs take up a larger share of the budget, the debt burden will continue to grow."
• On a positive note, U.S. inflation decreased from 3.7% in September to 3.2% in October. Similarly, Europe also experienced a greater-than-anticipated slowdown in inflation. The recent inflation statistics, combined with the current state of the labor market, are the key factors that will influence the Federal Reserve's decision-making in its upcoming meeting scheduled for December 12 and 13th.

 
Source: https://www.cato.org/blog/cbo-budget-economic-outlook-post-covid-fiscal-era
https://www.reuters.com/markets/us/moodys-changes-outlook-united-states-ratings-negative-2023-11-10/#:~:text=%22It%20is%20hard%20to%20disagree,burden%20will%20continue%20to%20grow.%22