Viewpoints

Watch for the Signals on Policy Direction Out of Washington

Expect the focus to remain on policymakers in D.C. for the foreseeable future.

With the federal government reopened and the debt ceiling extended, it is not surprising that markets have experienced a “relief rally” as investors cheer that the unthinkable – a default on U.S. debt – has been averted. Exhausted, if not disillusioned, by this most recent episode of political dysfunction, market participants are eagerly hoping for a reprieve from the uncertainty and brinksmanship that has characterized Washington recently.

Sadly, we do not anticipate getting much of a respite: Policy uncertainty is likely to increase once again near the end of the year as Congress yet again has to tackle important fiscal issues – and in an increasingly hyper-partisan context.

What should investors look for? One bellwether will be how the Congressional budget conference committee interacts and what, if anything, the committee produces.

What did the deal include?
As expected, the deal that passed Congress is another short-term, kick-the-can package that simply delays difficult decisions without meaningfully taking the threat of shutdown or default off the table. Also as expected, the bill (despite its bipartisan support in the Senate) only passed the House by Speaker John Boehner defying the so-called Hastert rule: securing votes from all Democrats but only a minority of Republicans.

What does the deal do? 1) It requires a bicameral bipartisan budget conference committee to create a budget blueprint for fiscal year 2014 by 13 December 2013 – though importantly, it does not include a “trigger,” an enforcement mechanism to ensure that a committee agreement gets signed into law; 2) it funds the government through 15 January 2014 at 2013 sequester levels; and 3) it extends the debt ceiling to 7 February 2014, with potential for the Treasury to continue to use “extraordinary measures” that will likely push the actual debt ceiling deadline into March. The deal also requires income verification for beneficiaries of “Obamacare” as well as provides back pay to all furloughed government employees.

Don’t expect a grand bargain from the budget conference
If the bicameral bipartisan budget committee that this deal sets up sounds familiar, it should: This is the eighth bipartisan budget commission since 2010. Optimistic observers think the budget conference could revive the prospects for a “grand bargain” – a comprehensive debt deal that substantively addresses our long-term entitlement challenges coupled with wide-ranging tax reform.

We are more skeptical, however: Without a trigger to align both parties’ incentives, we think that at best we may get some tweaks at the margin – reconfiguring some of the sequester cuts in exchange for some moderate modifications to entitlements (such as the way Social Security benefits are indexed for inflation – something President Obama has already endorsed). At worst, we think we could get a lot of rhetoric and name-calling without any real policy proposals. Why? The main obstacles to a grand bargain that have existed for the past two years continue today: Democrats won’t agree to substantive entitlement reform without material revenue increases (i.e., tax hikes), and Republicans, feeling they already have conceded too much on the revenue side in the fiscal cliff compromise, refuse to agree to any tax increases.

Will we have to live through this all over again?
The big question, of course, is whether we will have to endure yet another saga of brinksmanship and eleventh hour deal-making next year, when Congress is once again forced to address the debt ceiling and fund the government. Time will tell on this question, but it won’t be a long wait.

Right now, there’s tremendous hostility on both sides of the aisle, not to mention considerable tension within the Republican party. Some congressional Republicans – feeling they lost big in this fight – are readying for another. However, other Republicans have conceded that this was a losing strategy (Senator Lindsey Graham called the package “a joke compared to what we could have gotten if we had a more reasonable approach”), and it is hard to conceive that Republican leadership in either chamber would want a repeat of this saga heading into the 2014 election cycle given the blow the recent episode has given to their already lackluster polling numbers.

If the budget conference committee approaches negotiations with a spirit of compromise, if concessions are made on either side – however small – and if a bipartisan framework for fiscal year 2014 is agreed upon, then the outlook is somewhat brighter. We could expect a much less contentious resolution to the 15 January 2014 government funding deadline, which could have positive spillover effects for the debt ceiling debate. If, however, the budget conference resembles what we have seen over the last three weeks – partisan bickering and a refusal to move from ideological positions – we should expect more turbulence in the beginning of the year.

Either way, expect the focus – despite possibly everyone’s wishes – to remain on policymakers in D.C. for the foreseeable future.

The Author

Libby Cantrill

Executive Office, Public Policy

View Profile

Latest Insights

Disclosures

Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517), PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd- Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Amsterdam and Italy Branches are additionally regulated by the AFM and CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH(Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products and services to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial product advice in the case of retail clients). This communication is provided for general information only without taking into account the objectives, financial situation or needs of any particular investors. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No.382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates, and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Edifício Internacional Rio Praia do Flamengo, 154 1° andar, Rio de Janeiro – RJ Brasil 22210-906.

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2013, PIMCO.