With the November 17 deadline looming, investors are, once again, contending with U.S. government shutdown risks. A newly elected House Speaker reduces those risks, and even if a shutdown occurs, we would expect a short-lived episode lasting no more than a few weeks. We see limited financial market impacts as likely, with risk of more acute headwinds if the standoff extends longer than expected.
In September, Congress passed a last-minute continuing resolution (CR) to temporarily avert a government shutdown. Passage of that CR ultimately led to the removal of former House Speaker McCarthy. With newly elected House Speaker Johnson proposing another CR, it looks unlikely that a shutdown will occur on November 17th. Instead, we expect an extension that pushes out the debate until January or April of next year. However, it is not a done deal, and Speaker Johnson seeking budgetary concessions to go along with military support to Israel potentially tees up a more partisan divide that could complicate the outcome of future negotiations. If a shutdown does occur, we would expect it to be short lived as political pressure to reach a deal is likely to be amplified by a shaky geopolitical backdrop.
Overall, we expect a contained financial market impact under our base case of a shutdown lasting no more than a few weeks (if at all), noting risk of more acute headwinds to sentiment if the standoff prolongs. On average, recent shutdowns did not materially weigh on equities, while interest rates moved lower into the standoffs and thereafter (see Exhibit 1, which shows the most recent four shutdowns lasting more than a few days). Given today’s backdrop, we expect broader macro and central bank developments to be the more central driving factors.
Since 1978, there have been 16 government shutdowns lasting an average of eight days. The most recent one in 2018 happened to be the longest (34 days), however it was a partial shutdown and most of the federal government’s functions were unimpacted (including defense). The economic impact has tended to be modest and short lived. The 2018 episode shaved a few percentage points off of quarterly real Gross Domestic Product (GDP), which was recovered in subsequent quarters. Most estimates project a 1-2% hit to quarterly GDP if a month-long full shutdown were to occur today, with most of the lost economic growth likely to be recovered thereafter. A longer shutdown could decrease GDP growth more acutely due to furloughed workers and broader headwinds to consumer confidence.
We believe a shutdown would lower the odds that the Fed hikes its policy rate in December. While not all government agencies would fully cease activity (e.g., essential services continue), a shutdown could disrupt the production of key economic data produced by government agencies. This includes reports on employment and Consumer Price Index. The Fed is unlikely to make major changes in the absence of such data, seemingly adding to reason to keep its policy rate on hold. However, while rare, we note that the Fed has adjusted rates during shutdowns before, so a move would not be fully off the table.
Beyond potential disruption to the flow of key economic data, we are monitoring several other shutdown-related risks. In 2011, S&P downgraded its long-term credit rating of U.S. debt to AA+. Earlier this year, Fitch followed suit. Moody’s has indicated it may do the same should a shutdown occur this year, citing political polarization and broader risks on debt affordability from higher interest rates. Across the two weeks surrounding prior downgrades (in 2011 and 2023), U.S. equities lost 9.7% (2011) and 0.8% (2023). We don’t expect a Moody’s downgrade would be a major equity market headwind this time around, but we believe it is worth monitoring. We also note an incremental step-up in fiscal headwind risk if Congress does not agree on full-year appropriation bills for fiscal years 2024 and 2025. The Fiscal Responsibility Act (FRA) was enacted this June to temporarily suspend the debt ceiling. Housed within the FRA is language that would trigger automatic budget cuts if Congress is funding the government through stop-gap CRs past April of 2024. While this suggests a decent amount of time to pass the 12 appropriation bills, talks have made little progress so far and we believe the risk is worth monitoring.
CONCLUSION: SHUTDOWN RISKS DOWN BUT NOT OUT
Matters in Washington, D.C. are notoriously difficult to predict, though recent developments point toward a near-term government shutdown being less likely. In a letter to colleagues, House Speaker Johnson proposed passing another CR to fund the government through early 2024. Doing so would buy the House time to sign the essential appropriation bills to avoid a shutdown. Congress is likely keen to get back to work after three weeks at a standstill and with urgent funding issues requiring assistance. Although, while a CR looks likely, Speaker Johnson is known to hold strong conservative views regarding fiscal spending. Seeing all appropriation bills through the finish line could be challenging given Johnson’s views and a narrowly-divided House of Representatives.
Special thanks to Hunter Hildebrand, Rotational Development Associate, for data research.
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