Because economic and market impacts of a potential shutdown would likely be limited, it does not warrant portfolio changes in the near-term.
After well over a year of anxiously anticipating an economic recession, the U.S. economy continues to look sound. However, as we enter the “fall of worry” there are several risks on the horizon this autumn: impacts from the UAW strike, rising oil prices, the resumption of student loan payments and the potential for a government shutdown. While history shows the economic and market impacts of government shutdowns are limited, there are certainly long-term implications of excessive deficits and debt.
September 30 marks the end of the fiscal year, but Congress has not passed all twelve appropriations bills required to form the new fiscal budget to fund the government. Unless this is finalized before the end of the month or a continuing resolution, or extension, is passed, the government will shut down until compromises are reached.
Importantly, a government shutdown does not equate to a default, like the debt ceiling standoff could have, and not every federal agency will be affected. Treasury auctions would continue, interest payments would be made, Social Security and Medicare benefits would be paid and essential federal workers like air traffic controllers and law enforcement would still come to work. However, a shutdown would mean select non-essential federal agencies would temporarily shutter and furlough their workers, and key data releases could be delayed, like the jobs report and CPI, critical inputs for the Fed’s November 1 FOMC meeting.
Still, history shows that the economic and market impacts could be limited. The longest government shutdown in history was 35 days from December 2018-January 2019. As illustrated in the chart below, yields fell as uncertainty mounted, and the S&P 500 corrected sharply. However, important context to this episode is that the FOMC met December 18-19 and struck a decidedly hawkish tone, vowing that rate hikes were not finished. This, in addition to the shutdown and thin liquidity around the holidays, put pressure on equities. In January, Chair Powell softened his tone and suggested a pause in hikes, and equities promptly began to rebound before the shutdown had concluded.
From an economic perspective, the CBO estimates that the 2018-2019 shutdown cost $11 billion and reduced real GDP by 0.3%, but about $8 billion was recovered once activity resumed. Roughly 800,000 federal workers were furloughed or worked without pay. However, impacted workers did receive backpay once the government reopened.
Because economic and market impacts of a potential shutdown would likely be limited, it does not warrant portfolio changes in the near-term. However, in the long run, national debt and deficits are on an unsustainable path, which will have implications on yields, economic growth and inflation.