Budget Fights Throw Wrench in U.S. Growth Engine

A failure to stave off the debt ceiling by Thursday, or any partial agreement that further delays uncertainty, will hit at the heart of consumer and business confidence at a fragile time in the nation’s economic recovery.

Retail sales are already in decline as uneasiness mounts heading into the key holiday shopping season and business travelers are among the bellwethers of corporate confidence reporting financial losses as a direct result of the shutdown.

If Washington’s infighting continues and the U.S. suffers a downgrade (Fitch Ratings late Tuesday placed the U.S.'s 'AAA' rating on 'watch negative'), the building pressure could derail the U.S. as it slowly rebounds from the 2008 financial crisis.

“This will do real damage to the economy – business and consumer psychology will slump even further amid this persistent and corrosive uncertainty,” said Greg Valliere, chief political strategist at Potomac Research Group, in a note to clients.

For retailers, the damage to consumer confidence has already been done.

Both the Gallup Consumer Economic Confidence Index and Gallup US Consumer Spending Index slid to fresh lows over the last two weeks and the IBT/TIPP measure of consumer confidence plummeted to 38.4 from 46.0.

"Consumers who had been showing signs of strength are now weakening,” said Kristina Hooper, U.S. head of investment and client strategies for Allianz Global Investors, in a note to clients.

While retail sales have actually been sliding since June, says Sara Quinlan, senior vice president of MasterCard Advisors, the recent steep declines in confidence couldn't have come at a worse time as retailers prep their inventory for the holidays.

In a recent American Express (NYSE:AXP) study, Lamar Bell, senior vice president of financing and former CFO of Golden Corral, said the threat of continued high unemployment and underemployment, unsettled tax policy, and uncertainty in health-care legislation offer “significant impediments to growth throughout the country” at a time when people are just starting to feel a little better.

“Their homes are worth a little bit more than last year (though a lot are still underwater) and the values of their 401(k)s have increased,” he said in the report. “But I believe that what is going on in Washington is causing consumers and businesses, in general, to be not as bold as they might otherwise be.”

Damage Already Done?

With so many uncertainties lingering, businesses and consumers are already facing key spending decisions, with the two-week-long shutdown prompting some executives to pull money from certain business operations to save costs amid the unknown.

In the AmEx report, 50% of the 519 chief financial officers surveyed said their primary concern was that political uncertainty and gridlock would have a negative effect on their economic growth over the next year.

And in a recent study by the Global Business Travel Association, roughly 40% of the 257 employers polled said the shutdown has had an impact on their company and employees.

The multibillion-dollar travel industry, which contributes considerably each year to U.S. economic growth, has reported headaches related to shuttered passport offices and forced layoffs that have led to cancelled bookings and meetings.

"The shutdown [and potential default] are damaging productivity and leading to lost business opportunities and revenue that can’t be recovered,” said Michael McCormick, GBTA Chief Operating Officer.

This can hurt employee morale and hold back business growth, he says.

While the outlook for the lucrative travel industry in 2014 remains bright, with the sector expected to grow by 7.2% to $288.8 billion according to the GBTA’s latest estimates, its progress could be stalled if further fighting ensues.

Calming Fears

However, there is reason to remain calm despite the sirens.

For one, Congressional budgetary headaches are nothing new. Corporate America has long dealt with infighting in Washington and some past political standoffs have even successfully helped reduce government spending and the deficit.

Meanwhile, the deficit actually shrunk this year, giving the U.S. government more flexibility in finding a solution. It also has a bit of wiggle room on the Oct. 17 deadline, with most of its checks, like Social Security and disability, going out at the start – not the end – of the month, notes Allianz’s Hooper.

“Odds are U.S. lawmakers will reach a temporary solution to the debt crisis before we hit the critical Nov. 1 deadline,” Hooper said.

The stock market will likely face some significant volatility in the hours, days or weeks until a potential solution is reached, but Hooper is even bullish on that.

“Investors with long time horizons shouldn’t get scared,” she writes, “rather they should look for opportunities to add risk assets to their portfolios.”