With less than two weeks remaining for Congress to reach a budget agreement for the U.S. federal government before the Oct. 1 deadline, the impending issue is expected to dominate headlines and political discussions. However, investors are advised not to overreact as history suggests that this shutdown too shall pass.
Treasury Secretary Janet Yellen expressed her views on the matter, stating that jeopardizing the strong economy with a potential loss of momentum is unnecessary at this point. While defense firms, certain healthcare companies, and government contractors may be directly affected, the broader market is more influenced by corporate earnings, interest rates, and other macro factors.
Although government shutdowns tend to gain substantial media attention, they typically have a limited impact on the market. Keith Lerner, co-chief investment officer and chief market strategist at Truist Advisory Services, confirms this sentiment, stating that while investor anxiety and short-term market volatility may increase due to uncertainty surrounding these events, historical evidence suggests minimal and temporary effects on the market.
Since 1976, there have been a total of 20 federal-government shutdowns, with the longest occurring from 2018 to 2019, lasting 34 days. However, the average duration of shutdowns has been only eight days. Analyzing the data provided by Lerner, the S&P 500 has seen higher returns during 10 shutdowns and lower returns during the remaining 10, resulting in an overall average return of 0.0% for all shutdowns since 1976.
There is also the possibility of a one-month continuing resolution to kick off the fiscal year for the federal government. This would allow more time for Congressional negotiators to reach a compromise but would also introduce another shutdown threat on Nov. 1. Consequently, this extended uncertainty could further contribute to short-term market volatility.
Ultimately, investors are encouraged to maintain perspective and consider the long-term implications of the government shutdown. While it may capture attention and induce temporary market fluctuations, historical trends suggest that the impact on the overall market is typically minimal.
The Potential Impact of a Federal Shutdown on the Economy
Multiple federal shutdowns in the 2024 fiscal year are not out of the realm of possibility, with a 25% chance of full-year continuing resolutions, according to Capital Alpha’s Byron Callan, an expert in the defense sector. He emphasizes that Department of Defense personnel are set to be paid on October 13, creating a strong incentive for a timely resolution.
While there may be short-term economic consequences, both real and perceived, Goldman Sachs economists estimate that each week the federal government remains closed results in a 0.2 percentage point reduction in gross domestic product (GDP) growth. However, this lost economic activity is typically recouped once the government reopens.
Monetary policy is another factor affected by a potential shutdown. The Federal Reserve, currently in the late stages of its tightening campaign, relies on official statistics from federal agencies to inform its decisions. Without this data, the Fed would essentially be “flying blind.”
The first significant data release impacted by a shutdown would be the September jobs report, scheduled for October 6. Subsequently, the September consumer price index, set to be released on October 12, would also be affected.
Though the Fed has alternative sources of information, such as state-gathered data and private-sector employment reports like the monthly ADP report, these sources do not provide as comprehensive a view as official data.
The Federal Open Market Committee’s next interest-rate decision is set for November 1. However, without timely data, it is likely that the Fed will opt to wait and observe rather than make any sudden moves.
Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, highlights the concern that a lack of official data would further contribute to worries about monetary policy being based solely on past information. In this scenario, economic updates would only arrive after the fact.
Currently, futures markets indicate a one-in-three probability of a quarter-point rate increase on November 1, according to the CME FedWatch Tool. However, if a government shutdown persists for an extended period, these odds could decrease further.
In summary, a federal shutdown can have significant implications for the economy, both in the short term and regarding monetary policy. It is crucial for a resolution to be reached promptly to mitigate these potential adverse effects.