19 Jan A government shutdown may not affect stocks much, but a bigger political battle brewing will
Investors tend to disregard the threat of government shutdowns, but there’s one reason this time around that they might want to pay attention.
True, a shutdown likely would have little effect on corporate earnings and long-term economic growth or the things that should matter most to investors with a horizon that goes beyond that of the short-term stock trader.
This particular event, though, could be a precursor to a larger battle in a few months over the government debt limit that actually could have longer-term implications.
Failure to reach accord on some simmering disagreements — children’s health care, defense and a border wall — would point at a tougher road ahead to keep the government operating.
“The potentially bigger problem is that Congress also needs separately to raise the debt ceiling before that becomes a binding constraint, as it almost did in 2011 and 2013,” Paul Ashworth, chief U.S. economist at Capital Economics, said in a note.
The debt ceiling has remained a nettlesome problem between Democrats and Republicans for years. Failing to raise the borrowing limit ultimately could cause the U.S. to default on debt payments, a move that would cascade through the economy. Government bond yields would surge and cause the cost of borrowing to soar as government debt loses its sterling credit rating.
Current estimates are that the government can continue to shuffle money until sometime in March before losing the ability to operate.
“If the debt ceiling bites, the Treasury could find itself unable to make debt payments, risking a technical default, or it could fail to make one of its regularly scheduled Social Security payments,” Ashworth said. “Nevertheless, the real risk is that a partial shutdown now makes it harder for Congress to agree on a deal to raise the debt ceiling in time.”
For now, that possibility is being treated as remote.
Stocks have had a good week amid the shutdown rancor — major averages were mixed in Friday morning trading — though government bond yields were on the rise.
In the past, markets have paid little mind to shutdowns, of which there have been a dozen since 1981. Wall Street has looked beyond the near-term ramifications and focused instead on the longer-term picture.
Source: Goldman Sachs Global Investment Research/Bank of America, U.S. Trust
“Government shutdowns are relatively infrequent and generally inconsequential to the financial markets, but they are nevertheless instigators of market uncertainty,” said Joseph P. Quinlan, head of market and thematic strategy at Bank of America, U.S. Trust.
Most of that uncertainty, however, is short-term, and likely will be so again unless there are indicators that a debt ceiling agreement is in jeopardy.
The House approved a compromise bill Thursday to keep the government running for the next several weeks, but its fate in the Senate looked sketchy Friday.
Fitch Ratings, one of three major agencies that rates U.S. credit, is monitoring the situation.
“Partial federal government shutdowns have occurred in the past and this shutdown does not have a direct impact on the sovereign’s ‘AAA’/Stable rating,” Fitch said in a statement. “Its main implication for the US’s sovereign creditworthiness would depend on whether it foreshadowed a further destabilization of US budget policymaking, or brinkmanship over the federal debt limit.”
Failing that, the economic impact should be contained.
A shutdown would take 0.2 percentage point off real GDP for each week it continues, according to S&P Global economists. However, much of that would simply be made up in subsequent quarters, as the lost revenue would find its way back into the economy once furloughed federal workers get back pay and offices reopen.
S&P, citing Office of Management and Budget, notes that the 2013 shutdown cost the government at least $2 billion while the two 1995-96 impasses cost $2.2 billion in 2018 dollars. That’s something, to be sure, but in the scope of a $19 trillion economy, not much more than a rounding error.
“The question now is how long the shutdown will last, as that will determine what, if anything, the economic impact could be,” said Craig Earlam, senior market analyst at foreign exchange broker OANDA. “The last shutdown lasted a couple of weeks and the long-term impact was marginal, which may explain the current relaxed attitude towards another.”