BofA Merrill Lynch has lowered its Q3 and Q4 U.S. GDP forecasts on the expectation that the government shutdown will extend another week, resulting in decreased government spending and attendant “significant spillovers into the private sector.”
The bank is adopting its 1.7%-annualized tracking estimate of of Q3 GDP growth as its official forecast, which would mark a slowdown from Q2’s 2.5% annualized pace of growth. It also lowered its Q4 growth estimate to 2.0% from 2.5%.
“Both we and the consensus have had a baseline forecast that the government shutdown will be too short to impact 4Q GDP growth,” write BAML economists Ethan Harris and Michael Hanson in a note to clients. “However, with the shutdown approaching its one-week anniversary and with both sides digging in their heels, that assumption is looking increasingly untenable. Our forecast is quickly becoming a ‘best-case scenario’.”
Harris and Hanson expect the shutdown to persist another week for three reasons: “inside the beltway thinking,” evidenced by little change in the rhetoric out of Washington; no obvious end game surrounding the battle over Obamacare; and the lack of pressure from the stock market and the economic growth picture (as government data releases have been postponed).
“Ironically, a resilient stock market and a cloudy economic picture increase the risk of an extended shutdown in our view,” they write.
The BAML economists explain how this hits economic growth:
Our new baseline assumes a two week shutdown, but no violation of the debt ceiling. As a result, we are cutting our 4Q GDP forecast from 2.5% to 2.0%, but assuming some bounce back, we have added 0.3pp to 1Q growth. In addition, our tracking model points to just 1.7% 3Q growth and we are adopting that as our official forecast. The forecast change also impacts our Fed call: while a December taper is still possible, more likely the Fed will wait until January to start tapering and we see virtually no chance of tapering at their October 29-30 meeting. We still do not expect the first Fed rate hike until end-2015 at the earliest.
Digging into the details, half of the revision to 4Q is from lower government spending and the other half comes out of consumption and investment. Note that a partial shutdown directly reduces GDP growth by about 1% due to layoffs and cuts in government services. Table 2 summarizes government furloughs by agency and major program; at least 800,000 federal workers are currently “non- exempt” and thus not reporting to work.
In the 1995-96 episode, the government shut down from November 14 to 19 and then again from December 16 to January 6. The Bureau of Economic Analysis estimates that this directly cut 4Q GDP by about 0.3%. In recent press reports, most analysts point to this as the full impact of a shutdown today, but in our view there will also be significant spillovers into the private sector. Many sectors that rely on the Federal government for approvals or information are impacted. The tourism and travel industry is hurt by the shutdown of national parks. And companies in the defense industry are already starting layoffs.
Even if the shutdown doesn’t last another full week, Harris and Hanson say they won’t flip-flop on their forecast.
“Unless they agree to both an extended continuing resolution and an extended increase in the debt ceiling, we will stick to our weaker growth call,” write the economists. “As we have noted before, the risk to the economy comes not just from the shutdown, but from repeated rounds of brinkmanship that undercut consumer, business and investor confidence. Indeed, if this goes on long enough, we plan to cut growth our growth forecast for next year as well.”