'Serious scars on the economy': what Wall Street is saying about the risks of a US shutdown

Investment bank analysts have warned that the upcoming U.S. shutdown could increase market turbulence and undermine investor confidence. Although in the past such government shutdowns have most often had only a limited impact on the economy and stock indices, Wall Street does not rule out that this time the risks may be higher due to political disagreements, possible layoffs of government employees and delays in the publication of key statistics.

The shutdown could undermine investor confidence, which has already been cutting back on investments in U.S. assets in recent years, JPMorgan analyst Mary Park Durham wrote.

"The upcoming shutdown could put more noticeable pressure on the stock market due to political wrangling, the economy's vulnerability to external shocks and measures already in place that have destabilized markets this year," Park Durham noted. She added that a government shutdown could paralyze federal agencies that collect statistics on key indicators like the consumer price index. This could affect the inflation-protected bond market (TIPS) and complicate the Fed's decision-making.

"For now, investors are advised to maintain their strategy by emphasizing diversification and investing in quality companies and alternative assets," the JP Morgan analyst emphasized.

The U.S. has experienced many shutdowns in recent years, but only a few have lasted longer than a week, UBS said. Short-term government shutdowns have little impact on the economy and markets, the bank added.

To understand where a more protracted scenario might lead, UBS analysts studied the performance of the S&P 500 index and 10-year Treasury bond yields during periods of prolonged shutdowns. The study included three cases: 1995-1996 (21 days of shutdown), 2013 (16 days), and 2018-2019 (34 days).

- The 1995-1996 shutdown had almost no effect on the markets: the S&P 500 index was flat (-0.2% for the week and +1.5% for the two weeks before the shutdown) and bond yields even rose slightly, according to the UBS table.

- In 2013, the effect was more pronounced, with the S&P 500 down about 1% and ten-year bond yields down 3-9%.

- The sharpest swings came during the longest shutdown in US history in 2018-2019: the index lost more than 7% in the week before the funding cutoff and more than 8% in two weeks, with bond yields down 9%. However, other factors - duties and Fed policy tightening - added to the pressure then, the bank emphasized. After the crisis ended, markets quickly went up, and the S&P 500 added about 1.6%.

- Each week of the shutdown reduces GDP by about 0.1%, said Morgan Stanley strategist Michael Zezas, citing data from the bank's economists. After the return of government employees to work, this effect is usually quickly smoothed out, but this time there is a nuance, he emphasized.

"The Trump administration is discussing the possibility of long-term employee layoffs during the shutdown. That could leave more serious scars on the economy," the strategist said.

According to him, the main risk is that markets may put weaker GDP growth into prices. Then the yields on treasuries will go down, stocks will be under pressure, and volatility will increase. These fluctuations may be temporary, but the absence of official statistics increases turbulence: investors start reacting to rumors and ignore real risks. As a result, even a short shutdown can cause a disproportionately strong reaction in the markets.

The main threat of a shutdown is a delay in the publication of key macroeconomic data, including the employment report, which will increase uncertainty in the markets, analysts at Freedom Broker said. Their note is at the disposal of OnInvest.

According to Freedom, historically such situations have resulted in a moderate sell-off before a government shutdown, and direct damage to the economy has been minimal. However, this time the risks may be higher due to the discussion of a scenario of mass layoffs, not just unpaid furloughs. At the same time, Freedom Broker sees the shutdown as more of a buying opportunity: short-term drawdowns can be used to enter cyclical sectors and small-cap stocks.

Funding for the work of the US government expires on September 30, and this creates the risk of a shutdown. The Senate has already rejected the House budget bill: Democrats opposed it because the document lacked a number of provisions, including the extension of subsidies that expire in 2025.

A shutdown occurs when Congress fails to pass funding legislation in time and the government is forced to cut back its operations. It is not a default: some "non-essential" employees go on unpaid leave or work without pay until funding is restored. Usually such shutdowns are short-lived - there have been 21 shutdowns in the US since 1950, and most of them lasted only a few days.

This article was AI-translated and verified by a human editor