Why the chances of a government shutdown this fall are already on the rise

If anyone thought that the recent debt ceiling deal would mean any sort of reprieve from government spending brinkmanship, a deal cut this week by Kevin McCarthy has disabused those hopes.

To try and move past a rebellion among his most conservative members, McCarthy agreed to a plan whereby the House will propose additional spending cuts in the months ahead during budget talks. These cuts would be in addition to those agreed upon in the debt-ceiling deal Congress approved earlier this month.

The move all but guarantees that partisan spending fights will continue to be Capitol Hill’s main output in 2023, with Democrats immediately rejecting the idea and pledging to block it.

The months of fighting to come could have a host of consequences for a still fragile US economy even though a government default is now off the table until 2025.

The chaos could be destabilizing to markets; both a possible government shutdown and mandatory spending cuts are waiting at the end of the road if the gridlock continues into the fall and winter.

During a tense hearing this week, Rep. Rosa DeLauro (D-CT) said the recently enacted debt ceiling deal provided “a path to funding the United States government on time” and with minimal drama. But she quickly added that the path appears to be gone now, saying if McCarthy persists and “we disregard the law of the land, we all but guarantee a shutdown in October.”

Here are some of the major milestones to watch in the months ahead and some of the possible risks to the economy.

Phase 1: A messy appropriations process this summer

Much of the early focus will be on the House Appropriations Committee, led by Chairwoman Kay Granger (R-TX).

Her committee will be charged with passing 12 different bills in the months ahead to set spending across an array of government operations like agriculture, education, homeland security and many more. This process – which was agreed to as part of the debt ceiling deal – is the key first step in the overall budget talks.

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The issue is that McCarthy’s agreement means those House bills are now set to be considered at a lower level based on fiscal year 2022 spending. The result is that House Republicans are now looking for about $120 billion in additional cuts to government programs beyond those that were agreed to in the debt ceiling deal.

Granger has said the Republican move is entirely legitimate and that the debt ceiling deal simply set “a ceiling, not a floor” on spending levels as Democrats on the panel like DeLauro have howled in protest.

The Senate Appropriations Committee is led by Sen. Patty Murray (D-WA). It and the House committee will proceed in parallel hearings this summer to put forth their own proposals at spending levels agreed to in the deal, setting up for a clash in the fall as both sides try to iron out the differences.

“The financial markets will have to watch this one,” wrote Greg Valliere, the chief U.S. Policy Strategist at AGF Investments, in a note to clients this week of the drama to come.

For his part, Speaker McCarthy has brushed aside the chances of permanent gridlock, telling reporters this week “you’ve got to be more positive.”

Phase 2: A possible government shutdown in the fall

The issue for plenty of observers is a possible government shutdown that could come on Oct. 1 without a bipartisan agreement. If the differences in approach between the House and Senate persist, the government could be faced with once again closing non-essential services this fall.

“Shutdowns often pressure equity markets, but only temporarily, as markets typically recover as soon as Washington emits signals of a deal to reopen the government,” notes Brian Gardner, Stifel Chief Washington Policy Strategist, in his own note this week.

The political risk here, however, “is not currently priced into the markets” and could become much more front and center to investors and the economy in the fall if there are no signs of compromise on the horizon, he added.

In addition to a shutdown itself, there are an array of fiscal deadlines in the coming months and other important items on Congress’s do list – from reauthorizing the FAA to the farm bill – that could get bottled up in a budget standoff. That chaos could spill into the broader economy.

Phase 3: Possible mandatory spending cuts on Jan. 1

If the gridlock remains unresolved this fall, attention will turn to an even steeper fiscal cliff awaiting Washington on Jan. 1, 2024.

The debt ceiling deal stipulates that if there is no overall budget deal in place by next year, discretionary government spending will be cut by 1%. Significantly, the cuts would be across the board and not only impact social programs but also hit defense spending as well.

Cuts of that type could be felt widely across the economy though lawmakers across the spectrum are likely to do everything in their power to avoid an outcome with such blunt cuts that would be felt from the Pentagon to places like the Department of Education.

But much remains to be seen in the months ahead with the most conservative members of the House for now clearly itching for another fight.

“We shouldn’t fear a government shutdown,” Rep. Bob Good (R-VA) told reporters this week.

Ben Werschkul is a Washington correspondent for Yahoo Finance.

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