The Real Economy livestream recap

The cost of a potential government shutdown and rising loan costs

Middle market businesses face higher financing costs, government shutdown looms

Sep 26, 2023

Key takeaways

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A potential federal government shutdown would hurt spending and economic growth.

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A shutdown would come just as the economy seems poised to avoid a recession.

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RSM Chief Economist Joe Brusuelas forecasts a 40% probability of a recession.

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Rising lending costs are squeezing middle market businesses.

Labor and workforce Economics

American middle market businesses are facing stressful times as they contend with challenges including rising financing costs to a tight labor market to a potential shutdown of the federal government, said Joe Brusuelas, chief economist for RSM US LLP, and Neil Bradley, executive vice president for the U.S. Chamber of Commerce.

In a wide-ranging discussion on Sept. 25, Brusuelas and Bradley outlined the economic impact of a government shutdown, which looms on Oct. 1 if lawmakers cannot agree on legislation that would provide funding.

“The simple fact is that it’s going to shave about two-tenths of a percent of gross domestic product for each week the shutdown continues,” Brusuelas said. In 2018, a shutdown lasted five weeks and cost the economy about 1% in gross domestic product. “The longer this goes on, the bigger problems this will cause,” Brusuelas said.

Although a shutdown seems inevitable in the absence of a political compromise, the question is how long the shutdown will last.

“Is it a 35-day shutdown like we saw in 2018, or a 16-day shutdown like in 2013?” he said. “My guess is it will be somewhere in between.”

Bradley zeroed in on the corrosive impact of a government shutdown. Businesses rely on government to fulfill many tasks, he said, and those would stop. He gave the example of a fisherman who had bought a new boat and needed a certificate to operate in federal waters during scallop season during the last government shutdown. 

“There was no one at the Department of Commerce to give him his certificate and he missed the season—and he almost lost his boat,” Bradley said. “There are thousands and thousands of examples like this that really impact the real economy.”

Where will this end? Ultimately, it is a scenario where nobody wins, Bradley said.

“All the prior shutdowns have one thing in common: They have never actually succeeded in changing public policy,” Bradley said. 

Avoiding a recession

What makes the potential shutdown all the more disappointing is that it would come just as the economy seems poised to avoid a recession and achieve a soft landing, a call that the Federal Reserve has embraced.

Brusuelas estimated that the economy has a 40% chance of a recession over the next 12 months, noting its resilience in the face of rising interest rates. He forecasts a 3% growth rate for the third quarter, though that is likely to diminish in the final quarter and early next year.

“We’re growing more confident by the day that we are going to stick the landing on this,” he said of the soft landing. “We’re not going to have the recession, even if we just sort of muddle through the final three months of this year and the first three months of next year.”

After that, he sees growth returning to a little above 2%, which would be higher than the long-term trend of 1.8%.

Price stability is a precondition of maximum sustainable employment.
Joe Brusuelas, chief economist, RSM US LLP

Rising financing costs

Still, the economy is facing headwinds. As the Federal Reserve has kept up is campaign to restore price stability, rising lending costs are starting to take a toll on middle market businesses. 

These businesses that make up America’s real economy are now casting a wider net to obtain financing, and when they obtain loans they are paying more, Brusuelas said.

In the most recent RSM US Middle Market Business Index survey, 36% of senior executives who needed to tap financing markets said they were moving toward nontraditional lenders in the shadow banking system. Rates from those lenders, which operate outside traditional commercial banks, can be around 15%, the survey found.

“That’s a sign of financial stress,” Brusuelas said. “It’s one of the reasons why the central bank has been more reticent in talking about future rate hikes.”

Brusuelas said that the Fed is most likely done raising its policy rate.

“We think they should be done,” he added. “When you’ve got good privately held firms with good balance sheets paying anywhere between 10% and 15% on average, just to meet payroll and finance expansion, that’s not where you want to be.”

Such a financial environment suggests that a tipping point in the economy is near, he said, adding that the Fed has even telegraphed rate cuts next year.

Still, businesses need to deal with the new normal of higher lending costs.

The question, Bradley said, comes down to duration: How long are the terms of loans that they secured, and how soon do they need to be refinanced? Many businesses were fortunate to have planned for the higher rates and locked in their financing at lower rates. But regardless of what they have done, Bradley said it was hard to predict where rates will go.

“You have to have a range of plans,” he said.

Summer of strikes

Through all of these challenges, business continue to grapple with a shortage of workers.

Nowhere is this playing out more clearly than in the auto industry, where the United Auto Workers union is waging a targeted strike against the big three automakers. It is just one of the rising number of job actions—more than 200 across industries including airlines, Hollywood and package delivery—that have taken place this summer.

The potential impact of the UAW strike, Brusuelas said, could be quite large if all the UAW members walked off the job. But so far, only a portion of the workers have gone on strike.

“I don’t see more than a modest drag on overall growth—very modest given the way it is playing out,” Brusuelas said.

Bradley noted that there are real consequences for those workers and businesses directly affected by strikes, like the families of the workers, or the restaurants that they patronize near the plants.

But on a bigger level, a change is taking place in labor relations in the United States, Bradley said.

“You’re seeing a lot more pressure being put on employers by the leadership of organized labor,” Bradley said. “You’re seeing demands get higher and higher, and that’s going to add to wage pressure.”

Citing other recent job actions that have taken place that were seen as victories for workers: “Is this a moment where union leaders feel emboldened to make demands that businesses may not be able to meet?”

Still, Brusuelas said, only 6% of the workforce in private industry is unionized.

“This isn’t the 1950s,” he said. 

Watch the recording for the full discussion: 

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