Throwing In The Tea Towel: Government Shutdown Averted?

A late afternoon update from Stone McCarthy's Nancy Vanden Houten provides some much needed clarity on the topic that will be next week's number one topic (absent another colored swan joining the clusterflock): the threat of a government shutdown. It appears that Obama's warning that it would "height of irresponsibility" to shut down the government over a spending battle may have pushed republicans to come to an compromise. From SMR: "Increasingly, it looks as though Congress will be able to pass legislation funding the government for the rest of fiscal 2011, which is now half over and ends on September 30." And naturally this is merely one more of those strawmen whose inevitable resolution will be seen as an upside catalyst even if the probability of a downside outcome is impossible: after all the US government can not afford a shutdown period. So the only natural outcome will serve as the latest piece of news to get the momentum algos ramping the market into overdrive even though there is nothing notably catalytic about this development.

From Stone McCarthy:

Despite pronouncements by Congressional leaders to the contrary, it appears as though the key parties involved have reached a tentative compromise on a deal to cut $33 billion in discretionary budget authority for fiscal 2011. That $33 billion would include the relatively painless $10 billion of cuts that were already passed as part of the last two continuing resolutions.

A final deal is by no means certain. The details of a compromise still have to be fleshed out. We've seen reports that Congressional staffers will be working through the weekend to iron out the specifics. Also, it's still up in the air whether a final bill will include any of the so-called policy riders that were part of HR1, the bill that cleared the House in February and that would reduce fiscal 2011 budget authority by more than $60 billion. Senate Democrats and White House officials involved in the budget negotiations have indicated they might be able to accept some "non-controversial" policy riders. Frankly, we've only seen Democrats identify those policy riders that would be off the table, including those that would eliminate funding for Planned Parenthood, NPR, and implementation of the 2010 health care law. We've seen conflicting reports about riders that would limit some of the authority of the Environmental Protection Agency. If Democrats refuse to accept any policy riders, it might give GOP leaders some leverage to push for spending cuts that are slightly larger than $33 billion.

The more conservative members of the Republican Party, including many in the freshman class, won't be happy with a deal that cuts 2011 spending by $33 billion. So the House Leadership will need a sizable number of the House's 192 Democrats to support a compromise. It appears, though, that House Speaker Boehner has decided that supporting a compromise that can pass the Senate is preferable to siding with the more conservative members of his party and provoking a government shutdown.

Will this create a lasting rupture within the GOP? At this point, we don't think so, but it might make it trickier for Speaker Boehner to get support for compromises on some of the bigger budget battles that lie ahead.

The positive outcome of this issue then opens the door to the next strawman catalyst: the proposed increase of the US debt ceiling, which also has no chance of not passing (the alternative is a default of the US), yet a favorable resolution will once again be spun as a market moving event adding another 10-20 points to the S&P.

We still project that Treasury will hit the debt limit on May 16, if it doesn't resort to the tools at its disposal to create room under the debt ceiling. Of course, we expect Treasury will use all means available to avoid breaching the debt limit.  We still expect that Treasury will have exhausted those tools and hit the debt limit on June 30. The forecast is subject to more than the usual amount of uncertainty, as we head into the all-important April 15 tax date (April 18 this year.) We expect Treasury to provide an update to its own forecast for hitting the debt ceiling sometime next week.

As we indicated earlier, on a purely technical basis, the US total debt already surpassed the ceiling, although loopholes such as incremental maturities of debt, bill redemptions, the "debt subject to ceiling" definition and other semantics will likely push D-Day until mid-April, ultimately depending on the dynamics of tax refunds and revenues over the next two weeks.

That said, look for both of these events to be consistently spun as key positive outcomes, even though the chance of these things actually not transpiring in a non-favorable light is non-existent.


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