Weathering the Latest US Government Shutdown

The US federal government shut down overnight after the Senate failed to reach an agreement on funding government operations before the September 30 deadline. During a shutdown, “non-essential” federal agencies and programs that rely on annual discretionary appropriations must cease operations until funding is restored. Historically, shutdowns have been short-lived—averaging eight days—and have had negligible economic and market impact. As such, well-diversified investors need not take specific portfolio action in response.

Shutdowns have become a recurring feature of US fiscal politics, with this marking the 22nd since the Congressional Budget Act of 1974. While most shutdowns have been brief, the most recent and longest was the 35-day partial shutdown from December 2018 to January 2019. The duration of a shutdown is difficult to predict, typically hinging on the gap between party positions and the degree of public backlash. Unlike the 2018–19 partial shutdown, which left some agencies funded, this is a full shutdown, furloughing and/or delaying pay for a larger share of federal employees, including defense. By mid-October, active military personnel could go unpaid, increasing pressure on policymakers to resolve the standoff.

Historically, government shutdowns have had marginal effects on the economy. Most federal outlays will not be affected by a full shutdown. Annual discretionary appropriations account for about 30% of total federal outlays, and only a portion of that is impacted. The affected workforce is also small, with federal civilian and military employees (excluding postal workers) making up roughly 2% of the US labor force. According to the Bureau of Economic Analysis, the 2013 full shutdown (17 days) and the 2018–19 partial shutdown (35 days) each reduced quarterly real GDP growth by less than 0.5 percentage points, with most lost output quickly recovered once operations resumed and impacted employees received back pay. Unlike previous shutdowns, the Trump administration has indicated they may fire, rather than furlough, some federal employees—potentially as a negotiating tactic or as part of ongoing efforts to reduce the federal workforce. Although this could have a more lasting impact than prior shutdowns, any job losses in the federal sector—though difficult on individuals—would still represent a small fraction of the overall labor market, limiting the broader economic effect.

A prolonged shutdown will delay important economic releases, including the employment report due Friday, complicating policymaker decisions and adding to broader policy uncertainty. Elevated uncertainty could eventually spill over into financial markets, raising volatility. Still, the historical effect of government shutdowns on market performance has been inconsistent. During each of the previous three prolonged shutdowns in 1995–96, 2013, and 2018–19, US equities traded higher to varying degrees. Performance was more varied for US Treasury yields and the US dollar, which experienced modest declines on average. It’s likely that performance was also influenced by other factors such as debt ceiling standoffs, which are not in play this time. For our tactical trade recommendations, a shutdown does not change our views. The potential for a shutdown to modestly lower US growth, interest rates, and the dollar supports our view to modestly underweight US assets versus non-US assets.

Overall, we expect this shutdown to follow the pattern of previous episodes and be resolved relatively swiftly. Even if it drags on, the growth impact will likely remain marginal and the market response muted. Investors should look beyond short-term noise and avoid hasty portfolio changes, relying instead on well-constructed, diversified portfolios to navigate any unexpectedly negative eventualities.