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1. Government Shutdown Spiral: Here's What To Know
- A government shutdown freezes critical services, costs billions in lost economic output, and erodes public trust.
- Federal spending drives 36.2% of U.S. GDP, meaning a prolonged shutdown could disrupt key economic growth drivers.
What you need to know: As of writing this, the U.S. government is speeding towards a shutdown as Congress struggles to pass a funding bill by the midnight deadline on December 20. Democrats and Republicans remain deeply divided, even within their own parties, making an agreement elusive.
Why it matters: A government shutdown disrupts more than just Washington politics - it threatens the economy and key public services. But only about 25% of federal spending, categorized as “discretionary,” is affected. Meanwhile, programs like Social Security, Medicare, and Medicaid continue, but non-essential federal functions grind to a halt1.
- Non-essential services - such as IRS tax processing, national parks, and research programs - pause during a shutdown, with employees sent home without any pay.
The economic cost could be steep – for instance, past shutdowns, like the 35-day closure in 2018-2019, drained $11 billion, with $3 billion permanently lost. Local businesses in federal hubs may suffer as furloughed workers cut spending, and prolonged uncertainty could erode public trust and unsettle markets.
Now the Dunham Deep Dive: This isn’t just political theater - shutdowns strike at the heart of U.S. economic growth.
- Remember, every dollar spent – whether on infrastructure, contracts, Social Security, etc. - flows into the economy somehow and creates a ripple effect. That spending becomes income for millions, who then spend it also, and the cycle repeats.
But this reliance cuts both ways. . .
Prolonged shutdowns freeze a significant portion of discretionary spending - halting critical projects and delaying payments to contractors. The uncertainty also undermines consumer confidence and creates market volatility.
- And if there’s one thing people hate – especially when investing – is uncertainty).
So how did we get here? Well, the roots of the current crisis go back to September, when Congress failed to pass 12 appropriation bills by the start of fiscal year 2025 on October 1st3. A piecemealed continuing resolution (CR) may have temporarily extended funding until December 20. But attempts to pass another CR - extending funding through mid-March - collapsed due to disagreements over policy riders such as disaster aid, agriculture subsidies, and debt ceiling increases.
Central to the chaos, there’s debate over the debt ceiling itself.
Pundits argue that eliminating it would remove an important check on government spending. But in practice, the ceiling has done nothing to restrain spending (just look at our $36 trillion in federal debt).
Meanwhile, most developed nations - like Canada, the U.K., and Germany - don’t have debt ceilings and avoid the repeated crises that plague the U.S. Instead, these countries manage borrowing through legislative processes, sidestepping the volatility caused by U.S. standoffs.
A government shutdown gambles with confidence in our politicians and economy, creating global ripples that can boomerang back to hurt the U.S. economy. Essential services falter, workers suffer, public trust erodes, consumer confidence dips, and creditors may grow skeptical.
Worse still, whether Congress avoids this shutdown or not, another budget battle looms in early 2025, trapping the nation in a cycle of perpetual uncertainty.
With political polarization deepening, prolonged gridlock is becoming more likely - and government shutdowns are lasting longer (see chart below).
The government will likely get funded one way or another, but this never-ending dance comes at a cost.
Figure 1: Bloomberg, December 2024
2. Two Expected Cuts, Sinking Markets, and Stubborn Inflation: The Fed’s Reality Check Just Hit Hard
- The Fed cut rates but warned inflation remains the top concern, signaling only two cuts in 2025 and prioritizing price stability over market support.
- Markets tumbled, with stocks suffering their second-worst losses of 2024 as investors adjusted to Powell’s stark message that the “Fed Put” is no longer a given.
What you need to know: The U.S. Federal Reserve cut interest rates on Wednesday. The move was expected, but Chair Jerome Powell made it clear that future cuts depend on taming inflation which has become stickier than policymakers expected.
Why it matters: Markets plunged as Powell’s warnings rattled Wall Street. Stocks endured their second-worst losses of 2024, while bond yields surged1. Investors scaled back their hopes for further rate cuts and faced the reality of entrenched inflation (which the Fed has been wrong about taming). The Fed's options are shrinking with prices rising and the labor market cooling.
Now the Dunham Deep Dive: On Wednesday, the Fed delivered a strong message that markets should expect only two rate cuts in 2025 as inflation has remained higher than they expected (shocker, right?).
Even Wednesday’s cut was a close call with Cleveland Fed President Beth Hammack dissenting preferring to not cut at all.
Before the meeting, “animal spirits” - aka emotions and instincts driving economic decisions, especially in uncertain times – were very bullish. Investors were chasing speculative assets like cryptos, overpaying for unprofitable firms, and behaving as if the infamous “Fed Put” – aka the belief that the Fed will always rescue markets at the first sign of trouble2 - was firmly in place.
Powell, however, set a different tone. He emphasized that the Fed’s priority is now inflation - not employment and certainly not propping up markets.
Keep in mind that with just 17 months left in his term, Powell seems determined to avoid Arthur Burns' legacy as the 1970s Fed chair whose early rate cuts reignited inflation.
The chart below lays it out. If Powell moves too soon or too aggressively (and perhaps he already has), inflation could roar back, tarnishing his legacy. He then risks joining Arthur Burns in history’s hall of mediocrity. . .
It’s like they say: history doesn’t repeat, but it rhymes. Powell’s place in the history books is on the line.
Time will tell.
Figure 2: BLS, Dunham December 2024
3. Brazil’s Breaking Point? Markets Reel as Debt and Currency Crises Collide
- Brazil’s financial crisis deepens as the real hits record lows, spreading contagion to stocks, bonds, and debt markets while investors hedge against a potential default.
- Soaring interest rates and a 21% currency plunge leave Brazil’s top companies struggling to manage dollar-denominated debt, amplifying financial fragility.
What you need to know: Brazil’s financial markets are unraveling. After the currency collapsed to record lows against the U.S. dollar, the contagion spread. Stocks, bonds, and local debt all fell as investors lost faith in the government’s ability to manage a deepening fiscal crisis. Traders are even hedging against a possible national default.
Why this matters: The collapse of the Brazilian Real (Brazil's currency) exposes serious risks for the nation’s top companies. They face a double hit between a 21% currency plunge and soaring interest rates set to reach 14.25% by March. This has left many firms struggling to manage dollar-denominated debt. An FTI Consulting study found half the sampled companies have leverage above five times gross debt to EBITDA, with 12 holding over half their debt in dollars, amplifying financial fragility and shaking market confidence as the turmoil deepens3.
Now the Dunham Deep Dive: Brazil is Latin America’s largest GDP ($2.17 trillion) and is positioned as the world’s 9th largest economy.
For context, Argentina’s economy - which has caused global concern with defaults - is less than a third of the size. So, what happens in Brazil matters - especially for emerging market investors.
It’s all beginning with the financial world becoming increasingly skeptical of President Luiz Inacio Lula da Silva’s ability – or political stomach - to control Brazil’s soaring fiscal deficit. The country’s budget gap has swelled to 10%, far surpassing levels from Lula’s first term and greatly hurting efforts to stabilize public finances which are spiraling out of control.
This has left the Brazilian central bank (the Banco Central do Brasil) to carry the load. It’s hiking interest rates to try and rein in inflation, cool an overheated economy, and bolster the currency.
But such moves feel desperate. . .
And investors can smell it. Thus, they’re staying away.
In fact, this week, the central bank carried out some of its biggest interventions since the pandemic, pumping $5.8 billion into the market through spot auctions to try and protect the currency. And while each attempt gave the real a brief boost - it quickly sank again4.
Thus, despite holding $360 billion in dollar reserves to protect its currency, Brazil is burning through them rather quickly. Investors now worry it’s a case of throwing good money after bad, as the reserves fail to stop the real’s decline.
This comes amid a broader global U.S. dollar shortage I’ve written about before (read here if you haven’t), driven by a strong dollar and higher U.S. interest rates, which are squeezing emerging markets like Brazil and their debt-laden companies.
Unfortunately, this pressure is likely to worsen before it improves.
We’ll keep monitoring this trend and share updates as they come.
Figure 3: Bloomberg, December 2024
Anyway, who knows what will happen?
This is Just some food for thought as we watch how these trends develop.
As always, we’ll be keeping a close eye on things. Enjoy the rest of your weekend.
Sources:
1. Wells Fargo - 'Twas the Night Before Shutdown
2. Government spending in the United States - Wikipedia
4. Key takeaways from the Fed’s third rate cut | CNN Business
5. Greenspan Put: Definition, Examples, Vs. Fed Put
6. World’s Worst Performing Currency Hurts Dollar Borrowers in Brazil - Bloomberg
7. USD/BRL: Brazilian Real, Stocks and Bonds Plummet as Panic Sweeps Markets - Bloomberg
Disclosures:
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