by
Global Research Analyst

Key takeaways

  • After the shortest shutdown in history, an extension has been passed to keep the U.S. government running through March 23, 2018.
  • A two-year spending plan is outlined, which includes increases for both defense and non-defense spending and an extension of the debt ceiling through March 2019.

What it may mean for investors

  • Short-term market risk from government uncertainty has been reduced. Yet, longer-term risks from rising federal deficits may pose challenges down the road.

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Why are we here again?

As a reminder, Congress was supposed to pass spending bills before the fiscal year began last October 1, 2017. However, following three previous extensions, the federal government shut down on January 19, 2018. Senate Majority Leader Mitch McConnell agreed to bring a debate on immigration to the floor of the Senate, and senators voted for a fourth extension to fund the federal government for three weeks.

To avoid the shutdown this week, the House of Representatives on Tuesday passed another extension to keep the federal government open through March 23, 2018 with the military funded through the end of the fiscal year on September 30, and community health centers funded for two years. It did not increase non-defense spending beyond current levels. The Senate responded with a bill that also would keep the federal government funded through March 23. The time between yesterday’s agreement and March 23 would be used to finalize details for a bipartisan, two-year spending agreement. The budget plan is estimated to increase defense spending by $165 billion and non-defense spending by $131 billion. The plan also includes an estimated $20 billion for infrastructure development and $80 billion in disaster relief. Of significant importance, the plan also is expected to include an extension of the debt ceiling until March 2019. After delays in the Senate, which resulted in the shortest federal government shutdown in history, the House voted to pass the extension.

How will this affect the U.S. economy and markets?

The positives are that both parties have come to an agreement, and this will potentially eliminate further short-term extensions. Yet, the effect on the federal deficit is not to be underestimated. On top of the recently enacted tax cuts, which are projected to increase the deficit but offset this somewhat with increased growth, this plan will increase federal spending significantly. Projections are that this may lead to persistent annual deficits, outside of recessions and recoveries, breaching $1 trillion  Economic growth likely will pick up with this increase in federal spending, but that may add to inflation pressures that already appear to be building.

Although equity and fixed income markets have mostly ignored the recent iterations of budget extensions, the potential risk of increased volatility (stemming from a shutdown) may be removed upon the successful passage of an extended budget. However, the need to continually fund ever-increasing deficits may eventually be acknowledged in fixed income markets. As record debt continues to be issued to fund these rising deficits, interest rates will likely rise accordingly. Market risk is transitioning from the short term to the long term, with taxpayers in the future becoming liable for greater federal deficits incurred today.