What investors need to know about a US government shutdown
Markets have tended to react to shutdowns as “mini crisis” events.
Key takeaways
- US government shutdowns occur when Congress does not pass bills to continue funding government agencies.
- There have been multiple shutdowns since the Congressional Budget Act was passed in 1974, and they have varied greatly in duration and impact.
- Financial markets tend to react to shutdowns with a typical “risk-off” response. These reactions have historically been relatively minor and quite temporary.
What happens in a government shutdown?
A US government shutdown occurs if Congress fails to pass the necessary bills to ensure federal agencies are fully funded and can continue to operate. Such disagreements are often driven by differing political agendas or divisions over certain issues leading to an unwillingness or inability reach some sort of compromise.
The current government funding ends at midnight on Sept. 30. There are multiple ways to avoid a shutdown; Congress can pass a short-term funding bill (known as a continuing resolution), or they can approve individual yearlong funding bills. However, given the tight time frame and current lack of progress, it’s unlikely that any full-year resolutions materialize before the deadline, meaning another shutdown is becoming more likely.
Earlier last week, the Office of Management and Budget instructed government agencies to prepare for layoffs of federal workers if a shutdown occurs. Historically, shutdowns have led to temporary furloughs of workers, not layoffs. If layoffs were permanent, fears of decreased government services and weaker economic activity will likely materialize. One of the major sticking points this time around seems to be Democrats’ insistence that any funding measures include an extension of the Affordable Care Act tax credits, which are set to expire at the end of 2025 and which Republicans have not supported.
There have been several shutdowns since 1974, when the Congressional Budget Act was passed. There are varying interpretations of the classification of these shutdowns, but around 10-12 have been considered “significant.” Some have lasted as little as a few hours, while the longest in December 2018-January 2019 lasted 35 days. The impact of these shutdowns varies as well. Generally, nonessential employees are most affected, such as those at national parks and museums. Prolonged shutdowns can impair economic activity and government revenue.
How have government shutdowns affected markets?
Historically, when a government shutdown occurs, financial markets tend to treat it as a “mini-crisis” event, triggering a typical risk-off reaction.
- Volatility generally rises across the board, and flows of capital tend to slow.
- Stock markets tend to sell off, although not materially.
- US Treasury rates tend to rally as their safe haven properties become appealing to investors.
- International market participants tend to devalue the US dollar due to a combination of less stability and declining interest rates.
Longer-term effects toward markets can include delays of economic data releases, which may cause unrest for investors and put policymakers such as the Fed in an uncomfortable position. From a corporate earnings perspective, companies tied to government contracts could face delayed or reduced payments if the agencies they work with are shut down.
Historically nearly all the shutdowns have been short-lived and were highly temporary in their disruptive impact. This would most likely be the outcome if a shutdown occurs tonight. However, the heightened uncertainty is not a good thing for markets, and given the recent political climate, it’s entirely possible this shutdown becomes more impactful than what’s previously been seen.
This is another example of when investors should remain disciplined in their reaction to news and market events and ensure they have a thoughtful, diversified investment approach that aligns with their risk tolerance to help mitigate the impact of these events.
