Q - Flag

What would a government shutdown mean to the markets?

Steve Donahoe, CFA

The risk of a shutdown on Oct. 1 is a distinct possibility.

Some members of the house want to de-fund Obamacare which is obviously a no go with Democrats, especially in the Senate.

If they can’t work out a compromise, many functions of the federal government will be shut down indefinitely on Oct. 1.

I think it is apparent that a long, broad shutdown could weaken an already modest economic recovery. Ben Bernanke even noted that “a government shutdown and, perhaps even more so, a failure to raise the debt limit could have very serious consequences for the financial markets and for the economy.”

Not to mention a shutdown and restart won’t be cheap as the 1995-1996 shutdown and restart cost an estimated roughly $1.5 billion.

The White House has some discretion in terms of what’s hit and what’s not, but based on the shutdowns in the mid-1990s, here is how we think it may play out:

  • Many, if not most, federal government offices, programs, museums, and parks would be closed for business. This could impact the travel business if the effects roll into next summer, especially.
  • Projects may be delayed because the agencies that work with federal contractors likely can’t issue the paperwork needed to move forward.
  • Entitlements likely get paid but we are not sure who is available to process that information.
  • Areas deemed critical will likely stay open, such as  areas that protect human life and property including:

                                        – air traffic control
                                        – national security
                                        – handling of hazardous waste
                                        – food inspections
                                        – border protection
                                        – maintenance of the power grid
                                        – disaster assistance

  • Taxes likely continue to be collected and bonds issued.
  • Mail will likely get delivered and courts will likely stay open.
  • It is likely Obamacare gets implemented in the event of a shutdown; which begs the question of what is gained by shutting the government down in that sense?

From a historical perspective, the U.S. government has shut down 17 times since 1976. Presidents Carter and Reagan had six each ranging from one day to about three weeks. The last shutdown was in late 1995 to early 1996.

So, given what we know about prior shutdowns, we think the risks to the markets of a government shutdown and/or reaching the debt ceiling are significantly lower than in the summer of 2011 primarily because of central bank support. With the lack of tapering they have made it abundantly clear that deflation is not an option.

Also, at the start of the debt ceiling debate in the summer of 2011, government spending and the budget deficit as a percent of GDP were 24.1 percent and 8.2 percent, respectively, not far from the highest levels since WWII (25.2 percent and 10.1 percent) reached in early 2010. However, with FY13 nearly complete, the Congressional Budget Office (CBO) projects government spending fell to 20.8 percent of GDP and the deficit to 3.9 percent; the progress has surprised, relative to most forecasts, so a messy process achieved exceptional results.

In terms of credit rating:

This summer, Moody’s upgraded the U.S. outlook to stable, and commentary on 9/24/13 indicated that even with a shutdown or debt ceiling delay, the country’s AAA credit rating is not at risk as Moody’s is focused on long-term debt trajectory and the debt ceiling and potential shutdown would be short-term events.

Growth potential may have been better back then, but conditions going into the shutdown appear to be pretty similar.

Interestingly, GDP growth in the first half of 1995 was around 1.4 percent and the growth in the first half of this year came in at about 1.3 percent.

A correction is likely a buying opportunity given global central bank support.