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I hope you enjoyed your weekend. Sorry for the delay this morning, I have Covid and recovering thanks to the brave doctors at Front Line.
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The big mover this week is Congress as it tries to pass three key bills (infrastructure, social/green bill, and debt ceiling). Fiscal 2021 ends on September 30 and without legislation to extend or suspend the debt limit, the government faces a shutdown. As usual, the necessary legislation is being used as a political football, with the deep divide between the Democrats and Republicans making for a particularly difficult scenario this time around. Something will eventually be passed but at what cost. Here is what is being debated.
The infrastructure bill: This bill is about $1 trillion and passed in the US Senate with bipartisan support. The current state of the bill is unacceptable to most Democrats in the US House because it doesn’t include their political projects such as “clean energy, social justice, etc.”
The social and environment spending bill: This $3.5 trillion is the House Democrats’ response to the slimmed-down “infrastructure bill.” It has chuck full of political agendas, taxes, and a new “green energy plan.”
Debt Ceiling: According to our watches, Congress has until Thursday to pass a bill to raise the debt ceiling. If they fail to do so, then we could see a shutdown of the government.
Legislative Battleground: House Democrats and Biden want to pass the increased $3.5 trillion spending bill without Republican support through budget reconciliation. However, they need Sen. Joe Manchin and other moderate Democrats’ support. Manchin has stated publicly he won’t support the bill. Failure to pass the bills will reflect on Biden who has increasingly looked weaker with his failure at Afghanistan and the Border.
Scenario 1: I think it is highly likely the Democrats in the House will pass the increased spending bills (at a slightly lower level) and debt ceiling limit bill in order to put extreme pressure on moderate Democrat Senators and Republicans. This will go over like “a fart in church” and cause a shutdown or serious shutdown scare as all bills fail to pass. The market will likely drop 3-10%, but could partially recover if the debt ceiling bill is passed in order for Congress to debate more. The key thing to know is that the Democrats and Biden are using the debt ceiling limit to create a sense of urgency to pass their spending bills. They will not want to give this away and will signal defeat for them. However, they don’t want to be blamed for a government shutdown.
Scenario 2: House Democrats pass the debt ceiling bill, infrastructure bill, and a much lower spending bill (say $1 trillion vs. $3.5) that Democrat Senators can support. I think this is the best strategy for Democrats as it allows a much-needed win for both them and Biden while avoiding a government shutdown. However, I am unsure that Pelosi has the support for this and it is unknown how moderate Democrat Senators will react to it. The market will likely not respond or be positive as it will signal “business as usual.”
Scenario 3: House Democrats fail to pass any bills and we have a government shutdown. Expect a full blame game between the Democrats, Republicans, and Biden. The market will likely drop 3-10% and will not come back until the shutdown is over.
It is a busy U.S. calendar this week with a number of important indicators. None will have much market impact individually, but all will contribute to the Fed’s overall policy calculus where many on the FOMC now believe the “substantial further progress” conditions for QE tapering have been met. Chair Powell has been more cautious given his concerns over the “substantial slack” in the job market. But he too is leaning toward scaling back asset purchases this year.
The condition for the labor market is “all but met” on a cumulative basis he noted last week. Hence, it won’t take much improvement in the job numbers to satisfy him and get his vote on tapering. We suspect that announcement comes in November.
While ISM, durables, income, consumption, and confidence will be monitored, fiscal policy will distract with the debt limit and a possible government shutdown looming at fiscal year-end (September 30), while negotiations on the big spending and tax bills are on tap as well.
The Treasury’s $183 bln in 2-, 5-, and 7-year auctions will also be interesting in this environment with a more hawkish Fed, a QE tapering on the way, and still hot inflation. There is a bevy of Fedspeak and we expect they will voice their support for a taper announcement later this year.
The September ISM (Friday) highlights as it includes timely information on manufacturing employment, production, inventories, and prices. We expect the index to dip back -0.4 ticks to the 59.5 level from July, versus the 59.9 in August. The slippage from the 18-year high of 647 in March largely reflects the negative impacts from materials and labor shortages and other supply constraints, rising prices, the spike in the Delta variant, and the waning impact of stimulus checks. All of the sentiment indicators have dropped on net through July-August from prior peaks, and we expect further declines into late-2021 toward more historically typical levels.
Other reports this week include August Advance durable orders where we forecast a 0.5% increase after dipping -0.1% in July. Support should come from a 0.5% bounce in transportation orders. September consumer confidence is expected to rise to 115.0 after a drop to 113.8 in August. A 0.2% gain in personal income is forecast for August, with spending rising 0.6%. Q2 Q2 GDP should be revised up to a 7.0% pace of growth, though the more relevant Q3 pace is now projected slowing to a 5.4% clip.
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