FAQs on the Markets and Economy
What is the impact of the U.S. government shutdown on the economy?
The government shutdown is now the longest in history and there’s no sign that the standoff will be resolved anytime soon. Some 800,000 federal workers have been furloughed or are forced to work without pay, and another 4 million contractors have also been affected. Small businesses aren’t getting loans, production has been put on hold, and permits are being delayed. So far, the direct shutdown impact on the economy as a whole is estimated to be fairly small. However, the longer the shutdown lasts, the bigger the risk is of broader damage.
According to the Council of Economic Advisers, the shutdown is currently reducing quarterly GDP by 0.13 percentage points every week. If it continues through the first quarter, it would subtract around 1.0-1.5% pts from Q1 GDP — enough to significantly slow but not derail economic growth.
Most but not all of that missed activity will be regained when the government reopens. Orders that would normally have been made will accelerate once the lights come back on, and we’ll see a brief spurt of activity that should make up for lost time. For now, the bigger risk to the economy is probably still that the current stand-off is just a prelude to a full-blown crisis over the federal debt ceiling later this year.
What does the defeat of the Brexit vote mean for the UK?
As the Brits would say, “This sure is a sticky wicket.” It leaves the U.K and the European Union without any clarity on the details of the UK’s planned departure from the 28-nation political block, which is scheduled for March 29.
Parliament defeated PM May’s Brexit plan by 230 votes, the biggest defeat in Parliament in modern times. The fact that the defeat was so large makes it difficult to see the plan getting tweaked and approved in a second vote.
May’s leadership narrowly survived a no-confidence vote. She will attempt to save the situation. There are several options ahead for the U.K. There could be new offers along with more votes, a new prime minister or government, a postponement of the exit due to another plan to be worked out with the European Union or something else.
Will the bull market continue in 2019?
Based on positive economic, earnings and valuation factors, we continue to be bullish positive on U.S. equities in 2019 — though more moderate returns are expected. Equity markets appear to have found their footing over the first few weeks of the new year, with the S&P 500 now up 13.5% from December lows.
More dovish signals from the Fed and a resumption of trade negotiations with China have improved investor sentiment, while earnings and company guidance released so far have been better than feared. However, we think it is too early to declare the correction over, and we suspect the repricing process may last several months until we get more clarity on these issues.
Although recent declines in stock prices have been severe, it is important to remember that market corrections are also normal and investors should prepare for the potential of further volatility ahead. Longer term, we continue to believe the fundamental investment backdrop today is more favorable than recent short-term moves and headlines might suggest.
It may take time, but we believe investors will eventually reconnect to the still-positive outlook, allowing the long-running bull market to continue over the foreseeable future.
Is the labor market going to get stronger?
It sure looks that way. But the pace of growth may slow in 2019, for several reasons.
It was very strong last year, due heavily to the major corporate tax cut. Many companies used some of their tax savings to hire more workers in an attempt to capture market share. The tax cut will not be repeated, so companies will not be able to enjoy another year of tax savings.
Also, it is getting harder and harder to find qualified workers. This is the top complaint among employers.
This strong demand for workers is causing an upswing in the number of workers leaving their current job (chart) to get another job, which usually pays more.
What are the credit implications of the partial federal government shutdown on municipal credit quality?
Over the near-term, it is unlikely municipal bond credit quality will materially be affected. The fundamental risk to state and local governmental issuers is the duration of the impasse, which amplifies the economic disruption the longer it persists as restricted resource flow slows the pace of fiscal expansion.
States have largely positioned themselves sufficiently during the current recovery (i.e., reserves and liquidity), which should support the capacity to counter the loss or delay in federal aid and grant contract revenue, but a prolonged scenario bears monitoring since legislative policy would likely become more difficult with time. Increasing demands on states to back-fill lost programmatic funding could force mid-course corrections to budgets.
For state and local governments, the regions where [non-appropriated] federal employment is concentrated, e.g., D.C. metro, the temporary loss of income is likely to reverberate through sales tax collections or other consumption-based levies. How well a government responds to revenue underperformance or unanticipated expenditure growth will be important considerations. Contingency planning is typically a well-embedded feature of high-quality municipal issuers.
We continue to monitor the impact of the shutdown on state and local governments, as well as enterprises such as transportation, and will proactively address concerns should they surface.
What is happening with the Fed’s planned reduction in their balance sheet?
In what has been dubbed “quantitative tightening” or QT, the reversal of the Fed’s quantitative easing, the Fed is allowing bonds to mature out of their portfolio and not reinvesting the proceeds. The coupon payments still go to the Treasury. This is reducing the size of the Fed’s balance sheet, which now stands at $4.1 trillion, down from a peak of $4.5 trillion. They are on a path to reach $3.5 trillion by mid-2020.
Since late 2017, when the Fed began this passive reduction program, they have wanted it to be “as boring as watching paint dry.” And for most of the period it has been exactly that. But recently the markets have begun to worry about how much the Fed will shrink it. The Fed does not plan to bring it back down to the pre-recession level of $860 billion, mainly since their liability side of the balance sheet has grown. As the balance sheet shrinks, the bond market becomes livelier since the Fed is not buying as many securities, and this is occurring at a time the Treasury is stepping up issuance due to the ever-growing federal deficit.
What is City National Rochdale’s investment outlook for 2019?
Although it can be difficult to remain calm in the midst of market action like we’ve seen over the past couple of months, our advice is to stay disciplined and invested. Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed-income class.
Still, patience and discipline will be more important than ever. The investment landscape has grown more challenging as investors adjust to more typical late-stage conditions of higher inflation, rising interest rates and less accommodative monetary policy.
Meanwhile, concerns over slowing global growth, trade tensions and other geopolitical risks mean that markets likely will continue to be subject to periodic swings in sentiment and potential pullbacks. Both our equity and fixed income research teams have made deliberate risk-mitigating portfolio changes over the past year with the recent type of volatility in mind.
These decisions have helped fortify client portfolios to weather the turbulence we are experiencing, while leaving them well-positioned to take advantage of opportunities ahead should they present themselves.