MNI INTERVIEW:Long Shutdown Would Add To Reasons For Fed Pause

A prolonged U.S. government shutdown could make the Federal Reserve consider a temporary policy hold so as to avoid the risk of further destabilizing market and consumer confidence in a period of heightened uncertainty, former Dallas Fed principal policy adviser Evan Koenig told MNI.

A deadlocked Congress has yet to appropriate the funding needed to keep the federal government running at the start of the new fiscal year on Sunday, and an extended shutdown could hit confidence, consumption and disrupt financial markets ahead of the next Fed meeting from Oct 31-Nov 1. Traders last week saw a one in four chance of another quarter-point rate hike at the November meeting, though the odds have now fallen to 17%.

"Much is likely to depend on how disruptive the shutdown proves to be. Are financial markets skittish? Does consumer confidence take a big hit? Are there prospects for a quick resolution, or are the various players digging in their heels?" Koenig said.

"The usual arguments for waiting are: The Fed should not risk destabilizing an already skittish economy. If the Fed hikes, it will be all too easy for Congress and the Administration to blame the Fed for subsequent deterioration in the economy even if true responsibility rests elsewhere," he said. "Best not to muddy the waters."

POLICY PATH INTACT

The FOMC last week signaled it could raise rates a final time before holding at a peak of 5.5%-5.75% well into next year. Chair Jerome Powell ticked off a list of uncertainties clouding the economic outlook, including rising oil prices, striking auto workers and the looming shutdown. (See MNI FED WATCH: Proceeding Carefully To Peak Rates)

Past shutdowns, including the longest on record that started in December 2018 and lasted 35 days, added to near-term uncertainty and market volatility but had little long-term economic impact, as Powell noted. Even delays in the release of key data like September’s jobs and CPI reports aren't likely to seriously handicap the Fed's sense of how employment and inflation trends are evolving. (See MNI POLICY: Fed To Look To High-Frequency Data In Shutdown)

The exact timing of the Fed's next policy move, whether it's the November or December meeting, isn't that important, Koenig said.

"The broad trajectory of policy -- and more generally the Fed's reaction function -- is what matters," he said. "So, hold off in November but make it clear that action is likely in December if what appear to be current trends continue."