Bank of America's latest forecast on the resolution, or lack thereof, of the government shutdown, which now seems virtually certain to last at least one week into Monday night, when the House and Senate return to work, is hardly encouraging. The bank's base case now calls for "either a two-week shutdown or for multiple shutdowns." Additional, BofA has now cut its Q3 GDP forecast from 2.0% to 1.7% and from 2.5% to 2.0% for 4Q. It gets worse: "Much worse outcomes are possible. In our view, agreement is almost impossible as long as the Affordable Care Act is on the table." Finally, and what ties it all together, is that as a result of the lack of "government data", BAC now expects the Fed to delay tapering to their January meeting, or later. Which may well have been the much needed alibi all along to delayed tapering until 2014.

From Bank of America

The shutdown of the government has created a double dose of uncertainty. It comes at a time when the economy may be about to shift from second gear into third gear, triggering the beginning of a Fed exit. The longer the shutdown and the longer the games of brinkmanship, the longer the delay in that growth pick up. At the same time, the shutdown means almost no official data releases. In the face of this uncertainty, the Fed’s motto is: when in doubt, do nothing.

Our base case is now for either a two-week shutdown or for multiple shutdowns. We have cut our forecast for GDP growth from 2.0% to 1.7% for 3Q and from 2.5% to 2.0% for 4Q. We also expect the Fed to delay tapering to their January meeting, or later.

Much worse outcomes are possible. In our view, agreement is almost impossible as long as the Affordable Care Act is on the table. The President is very unlikely to agree to cuts in his proudest legislative achievement. Moreover, in our view, he is in a strong negotiating position vis-à-vis House Republicans. He does not have to run for office again, while they are all up for reelection next fall. Surveys show Americans strongly disapprove of the shutdown and put more blame on Republicans than Democrats. Surveys also show that Americans think it is not worth shutting the government down as a means to end the ACA. On the other hand, most Republicans strongly oppose the ACA and many support shutdowns as a means to an end. Ultimately we expect Republicans to drop the effort to weaken the ACA, but this could take a while.

It is very hard to measure the impact of the shutdown on the economy, although every economist has to come up with numbers. Most of the press reports seem very much on the low side, in our view. The direct impact is easy to calculate. The Clinton-Gingrich shutdown directly reduced GDP by about 0.3% in 4Q 1995 and a two-week shutdown today would have a similar impact. However, we think these narrow estimates are wishful thinking. There will likely be numerous spillover effects and, even if the shutdowns are brief, multiple brinkmanship moments will take a toll on confidence. We hear a lot of talk about buying on dips, but getting the timing right could be very tough.