T. Rowe Price: US likely to shut down this weekend. Now what?

T. Rowe Price: US likely to shut down this weekend. Now what?

29 september 2023

Verenigde Staten
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There is a possibility that the US government will temporarily shut down this Sunday. What are the implications for the financial markets?

As has become customary with the polarisation in Washington, we are up to another fiscal deadline and it seems likely that the US government will shut down on Sunday night. The consensus expectation is that the shutdown will be relatively short, two  weeks or so. What are the implications? Nikolaj Schmidt, Head Economistr at T. Rowe Price, comments:

Economics

'On the economics side, the overall implications are likely to be marginal. Naturally, there will be a near-term softness in demand as government spending is curtailed sharply and government employees are furloughed. This weakness will be offset when the government reopens, and back pay is disbursed. The near-term drag is around 0.2% (AR) of GDP for each week the shutdown goes on. Government shutdown underscores the polarisation and dysfunctionality of the current political system. A shutdown raises economic uncertainty marginally which serves as a headwind to investments and consumption.
Ratings agencies (Moody's) noted that the repeated evidence of dysfunctionality is a negative for the US credit rating. I do not expect a government shutdown to lead to another ratings downgrade. If it does, I would expect the impact from this to be marginal - but it will reinforce the rise in uncertainty.  A government shutdown will delay release of key datapoints such as inflation report and the employment data (non-farm payrolls). However, survey information produced by the Fed and employment data from ADP and initial claims will be available. Consequently, financial markets and policy makers will operate in a data fog but not a data vacuum. The government shutdown comes at a time when the economy is suffering from a few other distortions that, altogether, are likely to lead to a soft data picture. We see the return of student loan repayments, we have the auto worker strike and lastly, we will see the impact of the substantial increase in both oil prices and market interest rates. Whereas the former two are temporary distortions, the latter two presents are more serious challenges.'

Monetary policy

'In my view, at the current juncture, the Fed does not want to take any steps to support an easing of financial conditions. As such, a government shutdown will not be associated with a dovish surprise from the Fed. However, the outcome of the September FOMC meeting served to tighten financial conditions substantially and as such, I think the Fed will retain a hawkish stance, but the FOMC can wait for key data to become available before taking additional action. This is roughly in line with current market pricing.'

Market implications

'When uncertainty increases, investors tend to reduce the positions. On the night of the government shutdown, the market finds itself long US dollar versus other currencies and short interest rates. Additionally, as the data picture is set to become somewhat softer. Consequently, from a fixed income perspective, I expect the shutdown to lead to a depreciation of the US dollar and a moderate bond market rally. Equities and credit will benefit from some reprieve in the interest rate sell off however, softer growth data likely presents a headwind. Net, I expect the government shutdown to end up as a marginal negative for the equity market.' 
'The most concerning implication of the likely government shutdown is that it underscores the dysfunctionality of Washington D.C. This comes at a time where investors have started to ask question about whether the very large fiscal deficit can be financed. Gridlock and political polarisation are not conducive for a budget consolidation nor does it raise confidence amongst the US government bond investor base. Furthermore, without a substantial fiscal effort, the rise in interest rates is certain to keep the budget deficit on an upward trajectory. I see the government shutdown as the symptom, but the real problem is the illness that is political polarisation.'

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