US Strategy Weekly: Calm not Chaos

As the US faces a government shutdown, the financial media seems baffled by the apparent calm in the financial markets. Perhaps the media enjoys chaos, or likes to incite chaos, or perhaps they are overly sensitive to or impacted by the harsh political banter surrounding this issue. Nevertheless, there are several simple and logical reasons for the market’s calm.

First, each year Congress must pass, and the President must sign, a budget or a continuing resolution (CR) for the next fiscal year. This consists of 12 appropriations bills, one for each Appropriations subcommittee. Without a budget or CR, federal agencies must discontinue all non-essential discretionary functions until new funding legislation is passed. For example, contractors to the federal government may not get paid until a bill is passed. However, while the absence of a budget or CR directly impacts discretionary spending, it does not impact mandatory spending. Mandatory spending includes interest payments on debt, Social Security, Medicare, Medicaid, salaries for Senators and Representatives, and other personnel deemed essential. All essential functions of the government continue. Postal workers and military continue to work but salaries are delayed until a CR is passed.

Second, a continuing resolution bill usually includes an increase in the debt limit. However, the budget reconciliation law enacted on July 4, 2025 (known as H.R.1 – One Big Beautiful Bill Act) increased the debt limit by $5 trillion to $41.1 trillion. This was an important inclusion in the July 4^th bill since it allows the US Treasury to continue to issue debt and pay all its mandatory obligations without fear of reaching the debt ceiling in the near term. In short, it prevents a US default. Had the debt ceiling not been lifted in the One Big Beautiful Bill Act, it could have been breached, and the US Treasury might have had to employ extreme and unusual means to pay interest on its debt, if possible, and the prospect of a default would have thrown the financial markets into chaos. However, default is not a risk today, and the financial markets are calm. Note that debt held by the public was $30.1 trillion and intragovernmental debt was $7.3 trillion, for a total outstanding debt of $37.4 trillion, as of September 3, 2025.

The Bureau of Labor Statistics announced this week that in the event of a government shutdown the monthly employment report scheduled for Friday will not be released. In normal circumstances, this announcement would have gone unnoticed; but given the intense focus on monetary policy this year, data on employment and inflation are deemed crucial. However, in our opinion, it is not that crucial. Employment data has been notoriously “inaccurate” in recent years and the BLS already announced that the annual benchmark revision to the March 2025 establishment survey will lower employment by 911,000 jobs. Unfortunately, this estimate will not be finalized until January’s employment report published in February 2026. In the interim, since we know data is about to be dramatically revised should we care about Friday’s employment report? And in terms of monetary policy, the next FOMC meeting on October 28-29, is nearly a month away. In the absence of BLS data, there will be employment information from ADP to ponder. All in all, there will be inconveniences due to a government shutdown, but in our opinion, it is unlikely to impact financial markets.

Economic news was notably better than expected this week. Inflation, income, and real personal spending all came in at the higher end of expectations. In August, personal income rose 5.1% YOY up from 4.9% in July. However, we noticed that wages and salaries rose 4.9% YOY, which was down from 5.3% in July, and we will monitor this in coming months. Farm income, which can be volatile, increased in August and made most of the difference in wages. Disposable income increased by 4.5% YOY in August, down from 4.7% in July. But the most important statistic, real personal disposable income, increased by 1.94% YOY, up slightly from 1.88% YOY in July. Personal consumption expenditures rose a healthy 5.6% YOY, up from 5.2% YOY in July. Underlying data showed that the August increases in spending were primarily in durable goods and are unlikely to continue at this pace. See page 3.

The final estimate for second quarter GDP was 3.8%, the second upward revision for the quarter. This strong GDP number compares to a decline of 0.6% in the first quarter. However, the quarter-to-quarter swing in economic activity came primarily from imports. A sharp drop in imports in the second quarter was a counter swing to a surge in imports in the first quarter. Vendors built up inventories prior to tariffs expected in April. In terms of the trade impact of tariffs, net exports of goods and services subtracted 4.7% from GDP in the first quarter and contributed 4.8% in the second quarter. Total exports were relatively the same in both quarters, but imports added 5% to GDP in the second quarter, a reversal from the 4.7% subtraction in the first quarter. It may take several more quarters to determine the long-term impact of tariffs on net trade numbers and GDP.

Inventories were also a huge drag in the second quarter. Inventories, which added 2.6% in the first quarter, subtracted 3.4% in the second quarter as vendors reduced inventories. Federal government spending and residential investment were also minor drags in the second quarter. Consumer spending, state and local government spending and fixed investment grew modestly. See page 4-5.

The PCE deflator rose from 2.6% YOY in July to 2.7% YOY in August. This was the highest 12-month rate since April of 2024 and much of August’s acceleration came from food and energy service prices. The PCE deflator for food services climbed 3.1% YOY in August. Imported food products are experiencing the most dramatic price hikes as tariffs are increasingly being passed through to consumers. Although commodity energy prices are down, electricity bills are climbing. Housing and utility services increased by 4.3% YOY in August. A key factor is the surge in demand from the data centers that power artificial intelligence. We expect this trend will persist in coming quarters. See page 6. 

In the month of August, existing homes sales rose 1.8% YOY and new home sales jumped an unexpectedly large 15.4% YOY. New home sales were 800,000 units in August, the highest level since January 2022. The median price for existing homes was $427,800, up 1.9% from a year earlier while the average price was $562,800, up 3.1% YOY. The median price of a new home in August was $413,500, up 1.9% YOY while the average price was $534,100, up 12.3% YOY. New home prices are often volatile, but August’s data suggests the big surge in new home sales took place in higher priced homes. See page 7.

The pending home sales index increased to 74.7 in August, rising 4% over the month, but remaining well below the March 2025 level. Lower mortgage rates may be helping housing demand. The NAR 30-year fixed mortgage rate is currently 6.3%, down from 6.6% at the end of August and down from the 7.04% seen in January. In August, pending sales improved in all census regions except the Northeast; and on a year-over-year basis, pending sales were up 3.8%. Lower mortgage rates, rising home inventories and an increase in median family incomes, are slowly improving affordability. See page 8. Technical indicators maintain their bullish bias this week, though volume oscillators have not confirmed recent highs. This implies some short-term weakness is possible. We would be a buyer on a pullback.

Gail Dudack

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