Last week's meeting between Trump and Democratic leaders in Congress was fruitless: the parties failed to reach a funding agreement, leading to a shutdown. As a result, some 750,000 federal employees have been furloughed without pay. Employees who are considered essential must still report to work, although they won’t be paid until the government reopens, and who knows how long that will take this time.
While a government shutdown can be painful on a personal level, its broader economic impact is usually limited. Estimates suggest the U.S. economy loses around $7 billion per week during a shutdown, a relatively modest amount in the context of a +$30 trillion economy. As such, the initial drop in S&P 500 and Nasdaq 100 futures — down 0.8% and 1%, respectively — may well mark the market's peak reaction.
History seems to support this view: out of the last six shutdowns, markets only fell twice: once in 1996, when the shutdown lasted 21 days, and again in 1990, even though it only lasted three days. Overall, shutdowns usually don’t have a pronounced impact on the markets, since the country doesn’t typically suffer major economic fallout as a result, and investors understand that shutdowns eventually end.
A more tangible market reaction could emerge if the budget standoff drags on too long and ratings agencies decide that enough is enough, leading to a downgrade of U.S. sovereign debt. That would likely shake the dollar (DXY), rattle Treasury bonds, and hit the broader stock market. Plus, if — as Trump warned — mass layoffs of government workers begin, this political fight could become a real economic problem.
But why did this shutdown happen?
Some might argue that by allowing the shutdown, the president is trying to delay the release of key macroeconomic data, including this Friday’s labor market report. In reality, the dispute comes down to funding for healthcare and immigration. The “donkeys” are pushing for a “clean” short-term budget without additional spending, while the “elephants” are demanding continued subsidies for Obamacare and other social programs.
So, what’s the bottom line?
The shutdown is unfortunate, but it is unlikely to be enough to cause significant market declines. Therefore, we can generally expect a moderate reaction, similar to what we have seen in previous shutdowns. That said, confidence could also deteriorate if there are mass layoffs or the U.S. credit rating is downgraded. In that case, assets such as gold and cryptocurrencies, especially Bitcoin, could emerge as potential winners.