The US government doesn’t have to default for the debt-ceiling impasse to negatively impact the economy.
(Bloomberg) — The US government doesn’t have to default for the debt-ceiling impasse to negatively impact the economy.
That’s according to Sarah House, a senior economist at Wells Fargo who pointed to past instances when dragged-out debt-ceiling debates caused the stock market to decline and consumer confidence to plummet. House joined Bloomberg’s What Goes Up podcast this week to discuss her views.
Here are some highlights of the conversation, which have been condensed and edited for clarity. Click here to listen to the full podcast or subscribe below on Apple Podcasts, Spotify or wherever you listen.
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Q: Is this time different when it comes to the debt-ceiling debate? How big of a risk is it?
A: This is a significant threat and it seems we go through this exercise at least every couple of years and it eventually gets worked out and we’ve all become a bit numb to the debate. We think that this particular instance has the potential to be quite contentious. And reaching that X date and surpassing it, it’s a tail risk in our view, but it’s a significant one just given the catastrophic implications that it would likely have. So when we think about the split in Congress and even just some of the divisions within the GOP and how thin their margins are, this could very likely come down to the wire.
And I’d also point out that we don’t even have to actually reach that X date without a deal. But if it looks like it’s coming very close to the end of that period, you could still see a lot of collateral damage in the economy, particularly given the toxic political environment and perhaps not a lot of optimism that it might actually get done.
If you go back to 2011, for example, consumer confidence over the summer when we were having a very similar split in terms of Congress and the White House, you saw a confidence plunge that summer, you saw the stock market decline essentially 17% in just a matter of weeks. So you don’t even need to actually default on the debt for there to be real damage in the economy and particularly given that the overall picture is already getting increasingly fragile. It wouldn’t take a lot to accelerate that downward momentum if you did see another contentious debt-ceiling debate.
Q: The GDP print for the first quarter — was that surprising to you? Walk us through how you’re thinking about what we know about the economy after that report.
A: We’re actually below consensus in part because you did get some pretty significant revisions to consumer spending in the days before the release. So we had taken down our consumer-spending numbers, but in some ways it was surprising — just the degree of the slowdown, so a bigger drag from inventories. But, overall final demand from domestic purchasers was holding up. And that’s really the better bellwether for the underlying pace of economic activity. But we did see momentum slow over the quarter, and so we’re a little less optimistic that we can maintain the pace that we saw in Q1 as we look out further into the year.
Q: You’re anticipating a modest recession later this year. Tell us what’s behind that.
A: We are in the recession camp. We don’t think it’s going to be quite the doozy of the past few recessions. But when we look at just the degree of tightening that we’ve seen coming from the Fed and really just the severity of inflation, if the Fed’s going to be really set on getting inflation anywhere close back to its 2% target, it’s likely that we’re going to see demand need to pull back. And so we are expecting a contraction later this year in spending. We’re already starting to see some weakness coming out of the business-investment side. And this is really a Fed-engineered recession aimed at curtailing demand to stem that inflation pressure. Even before the mess of March, we were already seeing credit conditions tighten just as the outlook was deteriorating. We think that’s going to be an important part of this slowdown. And not just the availability of credit, but also the cost leading to businesses and households just getting a little bit more conservative.
Q: There’s a discrepancy between the manufacturing and services sides of the economy. How are you thinking about it?
A: One important aspect of that manufacturing-services divide in this cycle in particular is the nature of the crisis that we just came out of and what areas of the economy had done fairly well over the past few years and which ones have struggled a little bit more to get back on their feet. What’s so interesting about the Covid recession is that it was a boon for manufacturing. So typically when you see a downturn, that tends to be some of the more cyclical items, big-ticket costs. And so consumers retrench more. But just given the nature of the shock that we saw and the demand that resulted in physical things over experiences, that was a huge benefit to the manufacturing sector. So some of this pullback is cyclical, it’s in response to the higher-rate environment that we’re seeing, businesses cutting back on on capital-goods expenditures.
Click here to listen to the rest of the interview.
–With assistance from Stacey Wong.
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