The risks of a shutdown in the US

This is not the first time, but the USA is once again facing the risk of a government shutdown on October 1st. But what does this imply? Is this a risk for the financial markets? This is where we will see together if this can affect the economy and the markets.

What is a shutdown?

Before we begin, we will define the principle of shutdown. Already, the English term means “to close” in French. When we talk about government shutdown, it means stopping government activities, generally non-essential. This type of situation happens when there is no funding agreement from Congress on all projects (here 12 bills) before the next exercise date. For example: the financing of expenses generated by laws can generate disagreements between the different political parties (Republican and Democrat). There may be a stoppage of activities while an agreement is reached or a partial stoppage if only part of the projects has been voted on.

Congress has a majority of Republican representatives while the President of the US comes from the Democratic party. It is therefore logical to have disagreements on the financing of the budget.

The Bill Financing Disagreement vs. the Debt Ceiling Disagreement

This same type of disagreement took place when we had the topic regarding the debt ceiling. Republicans disagreed with Democrats on raising the debt ceiling to finance spending. The debt ceiling was reached in January 2023 and the representatives reached an agreement in June 2023. Time was limited since the treasury account was dry (almost nothing) at the beginning of June. That said, the consequences of refusing to increase the ceiling vs. the consequences of a shutdown are not at all of the same magnitude. The US is completely dependent on debt to stimulate the economy.

For example, if the debt ceiling would not have been increased, the US would not have been able to meet its obligations to repay the debt. Consequently, if we can no longer issue government bonds to finance all activities, this could severely affect the American economy. Moreover, there were some concessions to reach the agreement to increase the ceiling until 2024 between the two political divisions.

A shutdown could further impact those most in need, such as low-income families or students applying for student loans.

The consequences of a shutdown

This implies forced unemployment of civil servants. Therefore, you are asked not to come to work for a period of time (usually temporary). So they will not be paid during this period. However, they will subsequently be paid retroactively when the agreements are put in place. As for the others, they will also be paid retroactively according to the law.

On the other hand, it is generally a question of a cessation of non-essential activities such as discretionary services.

For example: passport processing may be affected resulting in delays as a direct consequence for travelers. There may also be delays with student loans. On the other hand, low-income families may no longer have access to the preschool program (Head Start) for children. National parks could close too. These are just examples.

As previously stated, not all sectors will be affected since the law will protect certain expenses. For example, Congress will protect spending related to Social Security.

Is this the first time we have faced a shutdown?

No, this is quite common in the political world. The question remains of knowing the duration of a shutdown which can be variable, depending on the time it takes to find an agreement. For example, in 2013, disagreements took place over OBAMACARE. The shutdown lasted approximately 16 days. We had another shutdown between 2018 and 2019 regarding the border wall (under Trump’s presidency). This disagreement lasted 36 days.

Everything will also depend on the number of projects affected out of the 12 financing projects. For example, in 2018, there were 5 projects out of 12 voted on. In this type of situation, it is a partial closure since the voted projects can be financed. In the current situation, we do not have any projects that have been voted on.

Market reaction to a shutdown

You should know that markets generally do not like uncertainty. Therefore, in this kind of situation, there may be more temporary volatility. However, a study was done on market reactions during a shutdown.

11 responded positive and 9 negative :

Therefore, it can be concluded that the reaction is quite mixed. There are probably more important issues on the table with higher consequences like inflation. Moreover, it still remains the major risk according to operators. However, a longer shutdown could cause concern. This could lead the American central bank, the FED, to reflect on the November decision at the FOMC. That said, the projections are still on the side of a pause, but perhaps the committee’s speech will be gentler.

The consequences on the economy

In the past, the shutdown has not necessarily had major negative impacts on the economy. Yes, there may be costs related to a shutdown, but it also depends on the context to absorb these costs. The only two times we’ve had both a recession and a shutdown, the recession had started well before the shutdown.

Everything will depend a lot on the context. Currently, we know that we have both inflation which remains the major concern but also strikes in the US (automotive sector) which are taking more and more space to adjust salary conditions to inflation. As we saw previously, reactions on the markets as well as on the economy are quite mixed. Everything will depend on the duration of the shutdown but also on the economic state at the time of the closure.

For the moment, the restrictive monetary policy of central banks has already slowed economic growth quite a bit and we do not yet know the full consequences of the rise in rates. Moreover, we can say that the job market is increasingly fragile and that the unemployment level has rebounded slightly. That said, it would take a move above the 50 mark on the RSI indicator to say that we have a trend.

CONCLUSION

A prolonged shutdown could add to public concern and weaken trust in political representatives. It all depends on the duration of the shutdown and the economic context at the same time. In a context like the current one where personal debt levels (credit card) are quite high, this could further affect those in need due to lack of resources.

DISCLAIMER

The comments and opinions expressed in this article are those of the author alone, and should not be considered investment advice. Do your own research before making any investment decisions.