US shutdown puts economy on knife edge

As investors cautiously pulled back from the markets, economists were grappling with how much a government shutdown could dent confidence in an already fragile US economy.
By · 2 Oct 2013
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2 Oct 2013
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As investors cautiously pulled back from the markets, economists were grappling with how much a government shutdown could dent confidence in an already fragile US economy.

Stockmarkets around the world have fallen this week, though the declines were relatively modest in the US, while negotiations in Congress remained stalled.

Asian shares and US currency held steady on Tuesday as Asian markets opened with no government deal in sight.

Many on Wall Street believe the direct hit of a shutdown will be relatively minimal to the factors that drive stocks. An estimated two-thirds of the government - the essential functions - will continue to operate.

But several economists have said the shutdown would most likely have a broader impact on market psychology if it lasted more than a few days, and could drag down an economic recovery that has had trouble gaining traction.

"You have an economy that has already shown some hesitation," said Diane Swonk, the chief economist at Mesirow Financial. "That's the last thing we need right now."

But Wall Street is more worried that the clash on the government shutdown could be a harbinger of fights over the government's borrowing limit.

The US Treasury Department has estimated it will no longer be able to issue new bonds after October 17 without authorisation from Congress.

Several Tea Party Republicans have said they will not agree to lift the debt ceiling without the White House making compromises - something the White House has said it will refuse to do.

If there is no agreement, the government would be forced to immediately operate on a balanced budget and could default on its debt - something that has never happened before.

"Before this week, I would have said to you that the odds of a government shutdown would be pretty small," said Charles Comiskey, the head of Treasury bond trading at the Bank of Nova Scotia in New York.

"What we are learning from this broken Congress we have is that anything is possible."

Large swaths of US business have come together behind the idea that the shutdown is a mistake that could have immediate economic repercussions. More than 250 industry groups signed a letter on Monday calling for a quick resolution to the stalemate, departing from the more mixed prescriptions business groups have given during past budget battles.

"It is not in the best interest of the employers, employees or the American people to risk a government shutdown that will be economically disruptive and create even more uncertainties for the US economy," said the letter, which was put together by the US Chamber of Commerce.

US President Barack Obama is scheduled to meet with members of the Financial Services Forum, which includes the chiefs of banks such as JPMorgan Chase and Goldman Sachs, who are in Washington for an annual meeting. The group is expected to discuss a range of issues, including the debt ceiling.

Investors are keeping a close eye on the market for US Treasury bonds, one of the most heavily traded markets, and a benchmark for the rest of the financial system.

If the government did stop paying interest on its outstanding bonds, they would most likely become less attractive.

But investors responded in unexpected ways the last time the government approached the debt ceiling in 2011, with investors flocking to Treasury bonds as a haven.

This time, the dynamics of the market are even more complicated because bond prices have recently been driven by bets on whether the Federal Reserve will ease off the bond-buying programs it has used to stimulate the economy.
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