By Anthony Mirhaydari
While Wall Street has its hopes up that Republicans and Democrats will find a way to extend the nation's debt limit by the deadline on Thursday, the fact remains that we're already in the fourteenth day of a government shutdown — the first in 17 years.
Moreover, the government refunding/debt-limit deals being discussed are only temporary measures to open the door to even more contentious long-term budget negotiations. Democrats want to open the government until December and push the debt limit off until mid-2014; Republicans want a shorter debt-limit increase but a longer government reopening.
The end result is that all the policy uncertainty and furloughed workers has already dealt a powerful body blow to the economy. And more is coming.
According to Societe Generale economists, the shutdown has already shaved as much as 0.5% from fourth-quarter GDP growth — at a time when the economy has been growing at an average annual rate of just 1.6%.
So we're talking roughly a one-third hit to growth. And, as I write this, there is no firm deal on the table to end the fiscal standoff. So there could be more pain.
The damage to confidence can be seen in last week's large drop in the University of Michigan Consumer Sentiment report, which well all the way back to levels not seen since early 2013.
There are knock-on risks as well, as America's fight pulls down the Europe and Asia. International Monetary Fund chief Christine Lagarde warned U.S. lawmakers risk causing a "massive disruption the world over" and tipping the global economy into another recession. The chart above of the Citigroup Economic Surprise Index shows just how closely the fortunes of the U.S. and euro-zone economies have been tracking each other over the last few years.
With euro-zone GDP expected to come in below 1% in 2014, it wouldn't take much more chaos out of Washington to cause the economies of our European trading partners to start contracting again.
Another point of concern, highlighted by Bank of America Merrill Lynch economists, is that before the shutdown caused government-supplied economic data to go dark, the "hard" data points like auto sales, retail sales, housing starts, home prices and industrial production were disappointing to the downside. It was the "soft" data, like the ISM manufacturing survey, that were surprising to the upside.
That suggests that, potentially, the pre-shutdown economic tailwinds were less robust than previously believed.
Moreover, I think the market is overestimating the prospect of a quick, bipartisan solution to the debt ceiling this week. Best case, according to reports out of the Senate, is that any deal might not get a vote until Thursday. That means the House won't have any time to make changes on any Senate package, vote on it, and send it back to the Senate for final approval.
So this is going to come down to the wire.
And blind optimism ignores the electoral reality that Republicans in the House have more to fear from a Tea Party-backed primary challenger from their district than a Democrat. According to the Rothenberg report, 211 Republican House seats are considered safe our of a 232 seat majority vs. 175 seats safe for the Democrats. Only 14 seats are considered true toss ups.
Finally, remember that this is merely the opening act in a multi-part fiscal fight that will take us all the way into the 2014 mid-terms.
For now, I continue to recommend clients maintain a large cash position and focus on opportunistic short plays like CEMEX /zigman2/quotes/203703444/composite CX +2.03%
Disclosure: Anthony has recommended CX to his clients.
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