With days to spare before Congress has to reach a deal to keep the U.S. government running, bond traders see a potential showdown breathing new life into the Treasury market’s rally.
Assuming France’s presidential election doesn’t roil markets, the April 28 deadline for Congress to at least pass a stopgap spending measure and avert a government shutdown looks set to take center stage this week, with the calendar mostly devoid of major economic data or Federal Reserve speakers.
The negotiations in Washington will kick in as investors have lost confidence in the prospect of the administration and lawmakers hammering out fiscal stimulus any time soon, although President Donald Trump intends to release a tax plan this week. Republicans’ failed attempt to overhaul health care and the infighting it revealed have damped expectations for Trump to achieve his policy goals and led 10-year yields to retrace half of their post-election surge.
Should an impasse on financing the government bog down the president’s agenda even further, bond bulls may be re-energized. Ian Lyngen at BMO Capital Markets sees scope for 10-year yields to fall to 2 percent should the standoff stretch into next week without significant progress. They finished last week at about 2.25 percent, not far from the lows of 2017.
“The Trump reflation trade has disintegrated as the failure of the AHCA tells you all you need to know about the prospects of Trump’s agenda,” said Tom Simons, an economist at Jefferies LLC, referring to the Republican health-care bill. “A government shutdown would be another nail in the coffin for that idea.”
On the equities side, bank stocks may be vulnerable if a budget deal can’t be reached. The KBW Bank Index has tumbled about 10 percent since this year’s peak on March 1 amid fading expectations for tax cuts and deregulation.
Speaker Paul Ryan told House Republican colleagues Saturday that a spending bill will be ready in time to avert a potential shutdown. And there’s always the possibility that lawmakers can pass a stopgap spending measure to keep the government running while negotiations continue. But if a deal can’t be reached and funding expires, the government will partially shut down, similar to what happened in 2013.
Federal workers are furloughed if their agency is part of the annual appropriations process, according to the U.S. Office of Personnel Management. During the 2013 shutdown, some government economic data releases were postponed and rescheduled. The October jobs report, originally slated for Nov. 1, was delayed until Nov. 8 because of the 16-day impasse.
The Fed, which isn’t funded via congressional appropriations, released meeting minutes as scheduled during the 2013 shutdown. This year, the central bank is scheduled to make its next policy announcement May 3. The government’s April jobs report is slated for release May 5.
Goldman Sachs Group Inc. strategists said in an April 19 note that they see only a one-in-four chance of a shutdown by the deadline, as it appears Congress will pass a “‘clean’ short-term extension that avoids controversial issues.”
The risk rises to “around one-in-three” if the budget debate extends into May, since lawmakers may eventually demand a longer extension through fiscal year-end on Sept. 30, “which would require resolution of any controversial items.”
One difference between now and 2013 is that the debt ceiling is a non-issue. Since the Treasury reinstated the limit in March, it has employed extraordinary measures to extend its borrowing authority. In 2013, the shutdown coincided with a deadline on the debt ceiling, heightening investors’ uncertainty.
That leaves the focus this time around on the risk of a shutdown and the damage it would do to market sentiment.
“A government shutdown is not going to be reflective of a smooth-functioning Congress in the market’s mind,” said Lyngen, head of U.S. rates strategy at BMO. "And the longer it goes on, the further out people would push their expectations for anything in terms of deregulation or tax reform."
What to watch next week:
Fed’s Kashkari speaks in CA
Chicago Fed National Activity Index
Dallas Fed Manufacturing Activity
FHFA House Price Index
S&P/Case-Shiller City Home Prices
New Home Sales
Richmond Fed Manufacturing
U.S. sells $26 billion 2-year notes
MBA Mortgage Applications
Retail Sales Revisions
U.S. sells $34 billion 5-year notes
Durable Goods Orders
Pending Home Sales
Initial Jobless Claims
U.S. to sell $28 billion 7-year notes
Fed’s Harker Speaks in Washington
1Q Annualized GDP
U. of Michigan Sentiment