Financial markets have been no stranger to concerns around political divisions in Washington in recent years. Markets endured the debt ceiling standoff this past summer and the threat of a government shutdown in late September. A last-minute deal kept the government open, but the short-term stopgap measure, called a continuing resolution, funds the government through Nov. 17.
Negotiations continue, and there is a new House Speaker who is seeking a temporary extension of current funding. But if a continuing resolution is not passed or expires, parts of the federal government that are considered nonessential would shut down operations and furlough workers until funding is restored.
While there are many uncertainties heading into the final days before the November budget deadline, we’d offer the following perspective on government shutdowns and their likely impact on the economy and the markets.
1. A government shutdown is not the same as a debt-limit default – When assessing the impact from a potential government shutdown, it is important to note that the current negotiations to keep the government funded are very different from the debt-ceiling standoff that took place in May. Unlike a debt-limit default, a shutdown does not affect the government's ability to pay its debt to bondholders and therefore does not have a direct impact on the government’s borrowing costs or creditworthiness. Treasury interest payments and Social Security continue to be paid, but millions of federal employees don't receive payments while the shutdown lasts. The personal impact on households should not be dismissed, but the furloughed workers will receive backpay once Congress resumes funding.
Here is a general overview of the impact of the shutdown on different government functions. For more detail and questions, please visit the websites of the respective agencies.
|What won't be affected||What will be affected|
|Treasury interest payments||Nonessential government employee pay delays, including active military|
|Medicare, Medicaid and Social Security payments||The Food and Drug Administration could be forced to delay food and safety inspections|
|U.S. Postal Service||National parks and monuments|
|IRS operations, but tax refunds can be delayed||The Securities and Exchange Commission (SEC) and the Commodities and Futures Trading Commission (CFTC)|
|Federal Aviation Administration (FAA) and TSA, but employee absences could lead to travel delays||Federal Emergency Management Agency (FEMA)|
|Military veterans' benefits||The EPA would pause plans and permit reviews|
|Food stamps and similar aid programs||Government data collection and reporting (example: monthly jobs report delay)|
|Law Enforcement||Small Business Administration would not be able to issue any new loans|
|Source: Committee for a Responsible Federal Budget, Edward Jones.|
2. Effects are disruptive but temporary - Shutdowns have been a regular occurrence in recent history but have not lasted long. Since 1976 there have been 20 government shutdowns lasting for a day or more. The most recent one in December 2018 lasted 35 days, setting a record as the longest in U.S. history1. But because Congress had passed some appropriations bills to fund parts of the government, 2018 was a partial shutdown, vs. the potential for a full shutdown this time, the last of which occurred in 2013.
From an economic standpoint, we would expect a short-term slowdown in growth around the shutdown period but a quick recovery in activity in the subsequent months. In other words, a shutdown would displace or delay spending and economic activity, not eliminate it. Federal workers will receive backpay, but contractors won't be compensated, and businesses that service the government would lose sales. Nevertheless, the economic damage would likely be minimal in the context of our $26 trillion economy, assuming the shutdown won't be prolonged. For perspective, during the most recent shutdown, the Congressional Budget Office estimated that roughly 0.4% was shaved off quarterly GDP over the five-week period, and other estimates based on the experience from the last decade point to a potential loss of 0.1%-0.2% from quarterly GDP growth for each week of closures.
This chart shows U.S. GDP growth in the quarter during a government shutdown.
This chart shows U.S. GDP growth in the quarter during a government shutdown.
3. Markets tend to look through the noise and focus on the fundamental drivers – The uncertainty that a potential government shutdown introduces can lead to a short-term uptick in volatility. But as with most political events, government shutdowns have historically had little lasting impact on equity performance. Stocks were positive half the time during the government closures and were higher in most cases three and six months later. More broadly, market performance tends to be driven more by the outlook for economic growth, earnings and interest rather than the political landscape.
While the Fed is likely done raising interest rates, it is warning against premature expectations of rate cuts, as economic growth has stayed resilient and inflation remains above its target. A potential disruption could be the shutdown of agencies that publish critical economic data like inflation and employment, leaving markets and the Fed in the dark, especially at this stage of the tightening cycle, which is very data-dependent. But we would expect policymakers to keep rates steady and wait to evaluate the data after the government reopens.
S&P 500 returns around government shutdowns
|Start date||End date||Duration||During shutdown||3 months later||6 months later|
|% of time positive||50%||60%||70%|
|Source: Congressional Research Service, Morningstar Direct, Edward Jones. S&P 500. Past performance does not guarantee future results.|
The bottom line
- Concerns about a government shutdown may add to the recent mix of factors, like the resumption of student loan payments and the autoworkers strike that have put pressure on markets. But while shutdowns introduce headlines of furloughed workers and disruptions to government services, history shows that the impact is typically short-lived, and we don't expect a shutdown to alter the outlook for the economy and financial markets.
- In our view, the favorable downturn in inflation over the past year, the notable resilience in consumer spending, and an approaching end to the Fed's rate hikes supports the case for a sustainable uptrend in stocks. This won't eliminate bouts of volatility along the way, but against this backdrop, we'd view market pullbacks, particularly any weakness spurred by government-shutdown anxiety, as a compelling buying opportunity, and we recommend a dollar-cost averaging strategy to take advantage of temporary swings in the market. We see opportunities in parts of the equity market that trade at lower valuations, and within fixed-income portfolios we see an opportunity to position for potentially lower yields next year by complementing CDs and other cash-like investments with longer-term bonds.
- The risk of a shutdown, and potential federal job furloughs, highlights that it’s always a good idea to review and fortify your emergency cash, even if a shutdown doesn’t materialize. In addition, don't let political uncertainties disrupt important decisions around your long-term financial plan. Our year-end planning checklist offers timely strategies to consider as we approach year end.
Angelo Kourkafas, CFA
Source: 1. Congressional Research Service
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