The US government could be shut down this week, if Democrats and Republicans do not agree on a budget for the ongoing fiscal year. This is just the first and simplest political decision on fiscal matters in a series of decisions coming up. Extending the debt ceiling comes next. The real thing is a medium-term strategy to put fiscal matters back on a sustainable path.

Markets are not that scared about this event because everybody knows it is part of negotiations, and that the US government would soon re-open. The 1995-1996 experience, when Republican Newt Gingrich rode the momentum of the previous mid-term elections to push President Bill Clinton on the same matter, has produced an example of the damage on politicians’ credibility and reputation, that it cannot last that long.

We do not believe a shutdown for a few days is a serious event, though it cannot certainly help economic recovery. The current debate and negotiations are clearly events investors are focused on, not necessarily main-street. Thus, relevant economic decisions on the aggregate are not yet affected, and a visible event as a shutdown could have an impact, especially if it does last more than a few days. However, we do not expect the shutdown, if it happens, to last long, which is why we have not yet changed our medium-term views.

The important issue here is the overall fiscal debate, and US fiscal sustainability through time. We are convinced the US has to produce a strong signal in the adjustment direction. We disagree that a fiscal adjustment is detrimental to growth when fiscal sustainability is in question. The UK and other European countries are bound to prove this point (others would most likely restructure, as the fiscal adjustments are not enough to return them to sustainability). As we have said many times, the US has more leeway than any other country, thanks to its size, credibility, and the fact that it issues the world’s reserve currency. However, the fiscal stance is unsustainable, and cannot be so forever. The debate is certainly established, and a few very decent and detailed proposals are on the table (Simpson-Bowles, Ryan, etc.). However, this budget negotiations and the debate around the next relevant negotiations do not seem conducive to a productive quick debate towards enacting something that would signal the world that the US is serious about its fiscal adjustment.

We believe that a strong credible signal is enough to reduce the probability that the US faces symptoms of a debt crisis in the short-term. We do not see anything happening soon, especially not while the economic recovery is gaining momentum. But if rates continue to climb, or growth plateaus at some point, symptoms could emerge. One possible symptom we have seen for a while is dollar depreciation. But it is also due to monetary policy and cannot be necessarily used to say we are at the heels of a debt crisis.

In sum, a government shutdown is relevant, and should have an effect, but it is not the real thing. What we need to be watchful of is the policy debate towards a real strong and credible signal towards fiscal sustainability, in order to reduce the probability of further faster depreciation and tougher more expensive UST auctions. A shutdown is part of a negotiation. What matters are the actions towards that signal, and not much has been produced yet in that direction. We are still waiting, with high hopes.