In all the spirited rhetoric over the Republicans' failure to pass Obamacare repeal and confusion over what lies ahead, many pundits and market watchers seem to have forgotten that a far more imminent threat, one due exactly one month from today, is that the US government may shut down. As
Axios further notes that the message CEOs took from Friday's fiasco, according to an executive at a money-center bank, was "Holy crap! We may be facing the same crap on a shutdown threat, and on the debt ceiling. Holy crap! We may not get tax reform, or a repatriation bill, or infrastructure spend, or substantial changes to regulations."
However, while we agree with the quoted republican that by and large markets are unprepared, they are starting to realize that a government shut down is becoming an all too real possibility, as the following just released note from BMO's strategists Ian Lyngen and Aaron Kohli.
The RBC duo note that they have been fielding questions about ‘what’s next’ for the administration in terms of legislative proposals – tax reforms? An infrastructure program to ‘Repave America’?
Here is their response:
While Trump would surely like the tax issue to be front and center, we’re starting to hear growing concerns that a government shutdown at the end of April may be a real possibility given the rise of the Freedom Caucus. Moreover, with the Democrats emboldened by their success in averting the repeal of Obamacare (at least for now), there is clearly less incentive to ‘play nice’ with the rest of Congress. In short, rather than clearing the way for tax reforms to take center stage, the healthcare bill mistakes might have more damaging implications for the effectiveness of the new administration than the Trump camp wants to admit.
In considering the market impact from the healthcare bill, perhaps the question shouldn’t be ‘what happens when tax reforms and infrastructure gets passed?’ and rather ‘what happens when the government enters a partial-shutdown on April 28th?’ To the latter question, that would certainly be a bullish event for the Treasury market and risk-off more broadly. The most straightforward implications are that the gridlock and relative strength of the opposition in Washington will simply slow pro-business reforms so significantly that markets will effectively price them out. After all, if Congress cannot keep the lights on in the Capitol building, how much confidence will the market have in their ability tackle the weightier issues of tax and infrastructure spending.
We’ll be the first to admit that we came into this year expecting that the debt ceiling debate would be a complete non-issue given what (at the time) appeared to be a unified Republican government. We were clearly a bit too optimistic, or politically naïve, and what’s currently playing out triggers flashbacks of the summer of 2011 when the US was downgraded by S&P as a polarized Congress wasn’t able to raise the debt ceiling quickly enough. While one might intuitively think that the risk of a downgrade would increase the cost to the borrower (i.e. higher yields), during the period of April 18, 2011 when S&P put the US on “negative outlook” to August 5, 2011 when the downgrade occurred, 10-year yields dropped from 3.40% to 2.56%.
There were certainly a number of other more tangible drivers at play behind the rally as well; slowing economic growth, the Fed’s quantitative-easing program, falling inflation expectations, etc. – but our broader point is that the market’s reaction to another ‘head-to-head’ debt-ceiling debate will be bullish for the Treasury market. If for no other reason than what it suggests will ultimately be delivered in terms of other reforms.
To be sure, traders have demonstrated an amazing ability to reallign the bullish narrative with any change in the underlying facts, so it is quite possible that we are just one month away from the market surging back to all time highs because a shut government is spun as positive for risk assets, the same Trump's healthcare bill failure has resulted in rising stock prices.