Key takeaways
A potential impasse over the federal government’s budget for fiscal year 2024 raises the risk of a government shutdown.
Congress has until the end of September to approve several budget measures or a stopgap bill to keep the government operating.
While past government shutdowns have certainly contributed to market volatility in some instances, the impact on capital markets and the economy over time tends to be limited.
Political standoffs between Republican and Democratic policymakers in Washington occur frequently, but sometimes with significant ramifications. A prime example is the growing dispute over the U.S. government’s fiscal 2024 proposed budget. An agreement to fund the government next year – or a measure to provide temporary funding – is needed by September 30, 2023, to avoid at least a partial shutdown of federal agencies, national parks and other government functions.
Similar events have occurred on several occasions in the past when Congress failed to reach a budget agreement by a prescribed deadline. The duration of most shutdowns is short, measured in hours or days. Three times in the past 30 years shutdowns lasted multiple weeks.
“In today’s political environment, it appears there’s a significant risk of a government shutdown at some point during the budget approval process,” says Kevin MacMillan, head of state and federal government relations at U.S. Bank. “With Republicans having a slender majority in the House and Democrats a slim majority in the Senate, there’s only a narrow path to resolution.”
What are the political realities of the current budget impasse and how might it impact the economy and capital markets?
The U.S. government needs an approved budget to underwrite federal government operations when the new fiscal year begins on October 1, 2023. With the deadline fast approaching, much work is needed in Congress to finalize the budget.
The current impasse follows a battle earlier in 2023 to extend the nation’s debt ceiling. House Republicans held off approving the U.S. Treasury Department’s ability to continue issuing debt to cover the federal government’s bills. However, at the eleventh hour, President Joe Biden and House speaker Kevin McCarthy came to an agreement that gained House and Senate approval and allowed the Treasury to continue issuing debt. That agreement included budget cuts for nondefense discretionary spending in 2024 and minimal increases for nondefense discretionary spending in 2025.
“The longer temporary funding continues, the greater the risk that an impasse that could result in a temporary shutdown before the year is out.”
Kevin MacMillan, head of state and federal government relations at U.S. Bank
However, a conservative block of House Republicans expressed a desire to see further cuts in nondefense discretionary spending beyond measures in the debt ceiling agreement. “This small but vocal group of House members sees the budget process as an opportunity to object to further government funding and pursue other aspects of their political agenda,” says MacMillan. Speaker McCarthy may face pressure from conservative members who could threaten his leadership position.1 A leadership fight has the potential of complicating efforts to reach a budget agreement.
MacMillan also notes that the current makeup of Congress causes additional issues. “Because the Republican majority in the House and the Democratic majority in the Senate are so narrow, the flexibility to craft legislation that can pass both the House and Senate is limited.”
Congress breaks the budget down into 12 different bills that fund various aspects of the federal government. Prior to its summer recess in August, the House had only passed one of those 12 bills. “It’s possible that one or two more of the 12 required bills may pass before September 30,” says MacMillan. “That means some government agencies will receive funding to continue operating, but not all areas are likely to be addressed by then.”
If Congress fails to complete the budget process on time, there are two likely outcomes:
Speaker McCarthy has indicated that he may seek to pass a continuing resolution to keep the government running, and Democratic Senate leader Chuck Schumer appears to be on board with that plan. However, potential obstacles stand in the way. “We may see a series of continuing resolutions passed to avoid a shutdown and keep the government funded over the closing months of 2023,” says MacMillan. “The longer temporary funding continues, however, the greater the risk that an impasse could arise resulting in at least a partial shutdown before the year is out.”
Federal government shutdowns are not a new phenomenon. Over the past four decades, the federal government has partially shut down on at least 10 different occasions. Between 1980 and 1986, four shutdowns occurred lasting only one day. Three other shutdowns extended just 3-5 days. Since 1995, however, three government shutdowns occurred that lasted much longer.
|
Date |
Length of Shutdown (in days) |
|---|---|
|
May 1980 |
1 |
|
November 1981 |
1 |
|
October 1984 |
1 |
|
October 1986 |
1 |
|
October 1990 |
3 |
|
November 1995 |
5 |
|
Dec. 1995/Jan. 1996 |
21 |
|
October 2013 |
16 |
|
January 2018 |
3 |
|
Dec. 2018/Jan. 2019 |
35 |
Date
Length of Shutdown (in days)
May 1980
1
November 1981
1
October 1984
1
October 1986
1
October 1990
3
November 1995
5
Dec. 1995/Jan. 1996
21
October 2013
16
January 2018
3
Dec. 2018/Jan. 2019
35
Source: United States Congressional Record.
“If a government shutdown occurs now, there are a number of reasons that it could last for an extended period,” says MacMillan. Among those are the hardline stance of some conservative House members, the tenuous position of speaker McCarthy among his fellow Republicans, the reluctance of Democrats to work with Republican House leadership, and the likelihood that presidential candidates will be speaking out in support of those pushing for budget cuts. MacMillan says those factors, among others, could limit the ability of Democrats and Republicans to find a compromise solution that will avoid a shutdown.
What form a government shutdown takes, should one occur, will not be known until it begins. “Typically, those federal government employees classified as ‘non-essential’ will be furloughed for the period of the shutdown,” says MacMillan. “However, the military and law enforcement agencies are usually not affected by a shutdown,” says MacMillan. He notes that historically, furloughed government employees, who will go without paychecks during the shutdown, will receive backpay and ultimately only face delayed, not missed paychecks.
What will it take to resolve the issues? “Eventually, if it goes on for too long, the impact becomes more severe, and policymakers are forced to come up with a solution to get the government funded and operating again,” says MacMillan. He adds that the timing of a budget deal is difficult to predict.
The biggest concern for investors is the risk of an extended government shutdown. “Although it’s an event that can create short-term hardship for those employees who are furloughed, the long-term impact of past shutdowns hasn’t tended to be broadly significant for the economy,” notes Rob Haworth, senior investment strategy director at U.S. Bank. “Even if there is a temporary decline in economic activity, it hasn’t been a major concern for investors.”
But Haworth also notes that the appearance of dysfunction in the policymaking process may have an impact on how bond rating agencies view the status of U.S. government debt. On August 1, 2023, Fitch Ratings downgraded its Long-Term Foreign-Currency Issuer Default Rating for the U.S., from its long-standing AAA rating to AA+. Among other factors, Fitch cites “repeated debt-limit political standoffs and last-minute resolutions (that) have eroded confidence in fiscal management.”2 “It appears this downgrade was in anticipation of potential turmoil over the budget,” says Haworth.
Beyond that however, Haworth says it’s not clear that investors have reason to expect a notable market reaction to a federal government shutdown, even one that’s extended. “The history of shutdowns is limited, but the data shows no definitive market reaction to these events, either as the market anticipates it, while the shutdown is underway, or after it is resolved,” says Haworth.
|
Dates of shutdown |
Duration of shutdown |
Total return 3 months prior to shutdown |
Total return during shutdown |
Total return 3 months after resolution of shutdown |
|---|---|---|---|---|
|
12/16/95 to 1/6/96 |
21 |
6.30% |
0.16% |
6.92% |
|
10/1/13 to 10/16/13 |
16 |
5.24% |
1.66% |
7.90% |
|
12/22/18 to 1/25/19 |
35 |
-17.10% |
10.43% |
10.90% |
Dates of shutdown
12/16/95 to 1/6/96
Duration of shutdown
21
Total return 3 months prior to shutdown
6.30%
Total return during shutdown
0.16%
Total return 3 months after resolution of shutdown
6.92%
Dates of shutdown
10/1/13 to 10/16/13
Duration of shutdown
16
Total return 3 months prior to shutdown
5.24%
Total return during shutdown
1.66%
Total return 3 months after resolution of shutdown
7.90%
Dates of shutdown
12/22/18 to 1/25/19
Duration of shutdown
35
Total return 3 months prior to shutdown
-17.10%
Total return during shutdown
10.43%
Total return 3 months after resolution of shutdown
10.90%
Source: U.S. Bank Asset Management Group.
In these three instances, when the budget impasse was significant and the shutdowns lasted for weeks, markets managed positive performance during the period of the shutdown. In two of the three instances (1995 and 2013), markets performed positively in the months leading up to a shutdown. In 2018, markets were down prior to the shutdown, but other contributing factors may have been at play, including the Federal Reserve’s decision to hike short-term interest rates during that period.
“A variety of issues impact the markets, even during stressful times like government shutdowns,” says Haworth. “But ultimately, investors are focused on more important fundamental factors such as corporate earnings and market valuations.” To the extent the shutdown doesn’t affect those fundamentals, Haworth believes it’s difficult to anticipate a specific market reaction to such an event.
While political issues such as the debt ceiling dispute, federal government budget impasse as well as the upcoming presidential election cycle can garner significant headlines, it’s important for investors not to allow these issues to distract them from long-term investment objectives.
Talk with a wealth professional to discuss your current portfolio to make sure your assets remain properly positioned to meet your financial goals consistent with your time horizon and risk tolerance.
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