It’s back to basics for the U.S. House of Representatives. Averting a shutdown may be hard and we highlight the ripple effects to financial markets.
October 12, 2023
By Atul Bhatia, CFA
Following the removal of Kevin McCarthy as speaker of the U.S. House of Representatives, we see a high probability of a partial government shutdown in mid-November. Critically – and quite different than our thinking around the shutdown risk in late September – we think this closure could extend for significantly longer than a symbolic 24-to-48-hour period.
The House speaker is a highly partisan role, and candidates typically rely on votes from their own party to be elected. If that precedent holds – and we believe it probably will – the election process looks complicated, since a candidate can only afford to lose a handful of Republican votes and still command the needed majority. The current House Republican nominee – Steve Scalise – has so far failed to command enough support to take office.
In addition to complicating entering office, the thin majority also makes it difficult for a candidate to remain in office. Current rules allow any single member to call for a motion to vacate, the procedural manoeuvre that was used to remove McCarthy. This leaves the incumbency of any speaker in the hands of any group of roughly 10 House Republicans, including the group that just deposed the last speaker.
Any speaker candidate knows this, and is therefore likely to be comfortable pushing an aggressively partisan policy platform. One result is that we think any pre-shutdown budget proposal from the new speaker is likely dead on arrival in the Senate and would never be signed by U.S. President Joe Biden. The odds of a pre-shutdown deal seem very low in our reading of the situation.
Under McCarthy, our view was that any shutdown was likely to be symbolic before a pragmatic deal was reached. We see greater risk of an extended shutdown under his successor for three reasons:
In short, we think the next speaker is likely to want a shutdown, and may be able to gain both a policy and a political advantage from following through with one. Unless polling changes dramatically around which party is blamed for a closure, it is hard to see why a shutdown would end quickly.
While it’s theoretically possible that a more pragmatic, deal-focused speaker could emerge, it’s hard for us to see how that result is politically viable.
A pragmatist has little to no chance of being elected using only Republican votes, in our view. As recent events demonstrate, deal-making and compromise are inconsistent with the current incarnation of the motion to vacate, and any move to amend that procedure would likely cost a candidate more votes than the slim Republican margin.
In effect, a deal-making speaker would likely need some measure of Democratic support to be seated.
We see this as unlikely for two reasons.
First, the Democrats would likely receive nothing for their support. Any commitment from a speaker candidate would be unenforceable; once seated, the candidate could renege and veer right and Democrats would be powerless.
Second, any commitment would likely be self-defeating. A speaker candidate that relies on Democrat support to be elected would, we believe, be tainted in the eyes of the average Republican voter. The result is that a Republican House member voting for such a candidate is risking their seat, most likely to a challenger from within their party.
One path for this type of solution would be a relatively senior Republican House member who would be willing to act as a caretaker, knowing that he or she could lose their seat in the next primary. In theory, this could work, with bipartisan pragmatic support. In practice, it’s likely a pipe dream.
There are wild card outcomes. The House can elect anyone to be speaker; there is no requirement it be a sitting member. We would not entirely rule that out, but we think it is a fairly remote possibility at this point.
Shutdowns have historically not caused significant immediate market impacts, as the table on the following page indicates, but it is difficult to draw robust conclusions given the paucity of data on shutdowns lasting more than 48 hours.
* The change in unemployment represents the month-over-month change between the start month and end month. For those shutdowns that lasted a few days, the change is “0” because the shutdown did not extend beyond the start month.
Source – RBC Capital Markets, Bloomberg, Haver Analytics, U.S. House of Representatives
This time around, we believe even a brief shutdown is likely to lead to Moody’s cutting the U.S. credit rating below AAA. We see limited direct impact from another ratings downgrade, although a shutdown and ratings move could add to governability concerns, potentially putting pressure on longer-term U.S. Treasury bonds.
Economically, a shutdown that led to a smaller budget deficit would likely prove disinflationary, which could prompt a faster shift to less restrictive policy from the U.S. Federal Reserve. We think bond investors would likely respond positively to that move and would also welcome any improvement in U.S. debt dynamics. A smaller federal budget would likely be a headwind to near-term growth and increase the odds of a U.S. recession, in our view.
An extended shutdown does cause damage, particularly to families dependent on government wages and payments, as well as to the myriad ancillary businesses and contractors that depend directly or indirectly on the U.S. for revenue. Missed payments are typically made good following a shutdown, so some – but not all – of the missed consumption would likely be recovered. The longer the shutdown lasts, however, the smaller the likely recovery percentage.
In this case, we think volatility is likely to increase in the run-up to a potential November shutdown, and we see elevated risk of a potential equity selloff. In a closure, we would favour high-quality fixed income, particularly in the middle part of the yield curve. Longer-term bonds may benefit from a potential improvement in U.S. fiscal dynamics, but that improvement may be offset by governance concerns.
This publication has been issued by RBC’s Wealth Management international division in the United Kingdom and the Channel Islands which is comprised of an international network of RBC® companies located in these jurisdictions and includes RBC Europe Limited and Royal Bank of Canada (Channel Islands) Limited. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by RBC’s Wealth Management international division.
This publication has been compiled from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgements as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, the value of investments and income arising can go down, future returns are not guaranteed, and an investor may not get back the amount originally invested. Countries throughout the world have their own laws regulating the types of securities and other investment products and services which may be offered to their residents, as well as the process for doing so. As a result, any securities or services discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law none of the entities which comprise the international division of RBC Wealth Management nor any of their affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBC Wealth Management.
Clients of RBC Europe Limited may be entitled to compensation from the UK Financial Services Compensation Scheme (FSCS) if it cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. For further information about the compensation provided by the FSCS scheme (including the amounts covered and eligibility to claim) please refer to the FSCS website FSCS.org.uk. Please note only compensation related queries should be directed to the FSCS. Royal Bank of Canada (Channel Islands) Limited is not covered by the UK Financial Services Compensation Scheme.
RBC Europe Limited is registered in England and Wales with company number 995939. Its registered office is 100 Bishopsgate, London EC2N 4AA. RBC Europe Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Royal Bank of Canada (Channel Islands) Limited (“the Bank”) is regulated by the Jersey Financial Services Commission in the conduct of deposit taking, fund services and investment business in Jersey. The Bank’s general terms and conditions are updated from time to time and can be found at https://www.rbcwealthmanagement.com/en-eu/terms-and-conditions. Registered office: Gaspé House, 66-72 Esplanade, St. Helier, Jersey JE2 3QT, Channel Islands. Deposits made with Royal Bank of Canada (Channel Islands) Limited in Jersey are not covered by the UK Financial Services Compensation Scheme. Royal Bank of Canada (Channel Islands) Limited is a participant in the Jersey Bank Depositors Compensation Scheme. The Scheme offers protection for ‘eligible deposits’ up to £50,000 per individual claimant, subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000 in any 5 year period. Full details of the Scheme and banking groups covered are available on the Government of Jersey’s website http://www.gov.je/dcs or on request.
Investment services offered by the Bank are not covered by an investor compensation scheme as there is currently no such scheme operating in Jersey, however ‘eligible deposits’ held pursuant to investment services may be protected under the Bank Depositors Compensation Scheme described above – for more information see the Bank’s general terms and conditions. Some of the products that the Bank might recommend to you could be registered overseas and may be covered by a local compensation scheme. Your investment counsellor will provide you with the details of any overseas compensation schemes (where applicable) at the time of making an investment recommendation.
Copies of the latest audited accounts are available upon request from the registered office. ® / ™ Trademark(s) of Royal Bank of Canada. Used under licence.