Markets have been relatively sanguine over the partial shutdown of the US government. The S&P 500 rallied 1% on Tuesday and 0.2% on Wednesday, even as the political impasse entered its 27th day. On the surface, this nonchalance appears justified. During the 14 shutdowns since 1980, the S&P 500 delivered positive returns two-thirds of the time, with an average return of 0.4%. And if a solution is reached in the coming days, we estimate that the drag on first-quarter GDP growth will be just 0.2 percentage points annualized – barely a pinprick on the US economy. But we believe the political stalemate could pose growing market and economic risks the longer it lasts.
- The economic cost will increase in a nonlinear manner the longer the shutdown persists. More of the roughly 800,000 government workers not being paid will be forced to cut back consumption as it continues. Worse, certain government services that grease the wheels of the economy will be compromised, including granting approval for mortgages, health insurance, regulatory approvals for firms and, potentially, personal income tax refunds. In extreme cases, government employees, including security workers at airports, could quit for private sector jobs given the recent labor market tightness. So while the first-quarter drag on growth could be as little as 0.2 of a percentage point if the shutdown ends now, the damage could increase to half a point if the dispute lasts through this month.
- The political dynamic could fuel concerns about a more market-sensitive conflict over the debt ceiling later this year. The federal government is set to run out of borrowing capacity around August, bumping into the debt limit. A similar standoff over this issue would have a more direct impact on markets, calling into question the timing of payments to holders of US Treasuries. While US politicians from both parties are keen to avoid such a standoff, a dispute could boost volatility ahead of any deadline. Further, government spending could plummet if a budget deal is not reached by 30 September, the end of the fiscal year.We remain cautiously optimistic that an agreement can be reached. President Donald Trump is under growing pressure to approve one. (Having taken responsibility for the shutdown, his disapproval rating has increased from around 52% to 55% in recent weeks, according to Real Clear Politics.) But the threats have been increasing and, in our view, support our conviction that equity overweight positions should be balanced by countercyclical positions to protect against volatility and tail risks.