Last week I highlighted the investment implications of
continued budget uncertainty:
. We didn't have to wait long - on Monday, equity market
volatility hit a multi-month high.
Unfortunately, high volatility will not be the only side
continued dysfunction in Washington
. If the current budget battle morphs into a protracted series of
short-term arrangements, raising policy uncertainty in the
process, the economy will likely suffer as well.
Historically, rising political and policy uncertainty - as
the Economic Policy Uncertainty Index (EPUI)
- has been associated with lower economic growth. Every 10 point
increase in the EPUI index results in a 0.2% drop in real growth.
Over the past few months, the EPUI index has surged from 100 to
160. If the index remains at these elevated levels, it suggests
that growth will be approximately 1% slower than it otherwise
would have been.
So what are the mechanisms through which political uncertainty
impacts economic growth? Here are two:
Periods of political and policy uncertainty undermine
investor confidence and negatively impact consumption.
When consumers are worried about government shutdowns and budget
battles, confidence tends to drop. In other words, even if
consumers have the wherewithal to spend, they are less inclined
Economic growth tends to be slower when political
uncertainty is high because business spending drops as
All else equal, a corporate CFO will be less inclined to
invest in new capital equipment or expand hiring when the
government is on the brink of a shutdown. In a similar way,
uncertainty over tax or regulatory policy is likely to be another
drag on investment spending. As a result, business investment
tends to drop as uncertainty rises, another factor contributing
gross domestic product (GDP
While a longer-lasting deal is still possible, given the
intransigence on both sides, a so-called "
Bargain" looks increasingly unlikely
. Instead, the best-case scenario currently appears to be a
short-term, last-minute deal that helps the country avoid a
default, and hopefully, reopen the government. However, such a
deal will likely mean we'll be back to where we are today in a
few months and political uncertainty will remain high.
Under this scenario, while the economy is still likely to
grow, it will arguably grow somewhat slower than it otherwise
would have. Ironically, despite Washington's role as the
epicenter of the crisis, an investment implication of this
scenario is that
Treasury bonds are likely to do better in the
as interest rates rise at a slower pace. Finally, economic damage
will be minor if this ends next week and there is a longer-term
solution. The longer this drags on - either through an extended
government shutdown or a short-term increase in the debt ceiling
- the more significant the damage.
Russ Koesterich, CFA,
is the Chief Investment Strategist for BlackRock and
iShares Chief Global Investment Strategist. He is
a regular contributor to
and you can find more of his posts