US government shutdown: What could it mean for markets?

If Congress fails to pass a spending bill by midnight of 30 September, parts of the US federal government will begin shutting down. It would be the fifth shutdown of the 21st century. So what is a government shutdown? And how might it impact markets?

A shutdown is not the same as default – there have been 21 such shutdowns since 1976. About 3mn federal employees could be affected.

Usually markets ignore shutdowns – most last only a few days and investors seem to take a long-term view of the situation, and the short duration of most incidents has little impact on company profits. The average length of shutdowns is eight days. In 12 of the 21 shutdowns the S&P 500 has risen during the event.

It could be different this time.

Firstly, deep political divisions could see this drag on. A longer shutdown could have serious consequences for stocks. In the 35-day shutdown of 2018-2019 the S&P 500 fell 14%.

The White House has also raised the stakes by raising the prospect of mass firings, effectively using a shutdown to clean up some spending it would like to cut. The Trump administration has sent a request for federal agencies to prepare “reduction in force” plans in case Congress doesn’t pass a spending bill in time.

Usually, a shutdown results in employees being furloughed, but Trump could use the situation to make spending cuts. This could have longer-term consequences, particularly if it drags on. The Congressional Budget Office estimates that roughly 0.4% was trimmed from quarterly GDP in the 2018/19 event. Jobless claims and the unemployment rate could rise.

If there is a shutdown, the length it takes to resume funding is important.

For markets, it’s worth noting that there could be a greater impact on equity markets and bonds markets due to recent economic policy changes and ongoing uncertainty that brings. Moreover, the US economy is in a vulnerable position – a shutdown could potentially tip it into recession.

Treasury yields ought to fall in a shutdown but recent jitters in the bond market and the twin threats of political and economic uncertainty could see them move higher. We could see a shutdown weighing negatively on the US dollar as it could force global investors to reassess their exposure to the US. Safe haven assets like gold ought to benefit.

Data gathering could be hampered, which could affect the TIPS market and even decision-making by the Federal Reserve. Regulatory oversight of financial markets could also be hampered if the SEC and CFTC were forced to operate on ‘skeletal staff’, while the pipeline of IPOs could be turned off.

Take a long-term view

Whilst there are concerns about a shutdown dragging on and weighing on growth, it should be noted that stock markets have generally done well after these events. In the 12 months following the 2018/19 shutdown the market gained over 25%. After the 2013 shutdown the broad market returned 20% in the following 12 months.

Essentially, we've had shutdowns before, investors haven't seem too bothered and when it has got dicey the market has always bounced back.

Summary: Shutdowns tend to be resolved quickly and have limited impact on markets. But this time could be different if it leads to mass firings and/or it drags on for longer than usual. It comes at a potentially risky moment for Wall Street.

A long shutdown could sap investor confidence in US assets for a period similar to what happened in April following the Liberation Day tariffs, which could present opportunities to investors who have a long-term view.

Ultimately the budget impasse holds a mirror up to longer-term concerns about fiscal deficits and unsustainable spending.