US government may shut down, and the risk is significant

The United States government is staring at a shutdown starting at 12.01 am (Washington, DC, time) on Sunday, October 1. This would mean a complete cessation of nonessential government services unless the US Congress passes the necessary spending bills or a continuing resolution that provides stopgap funding. A shutdown will have a ripple effect across the US economy, from federal workers not receiving their salaries to households potentially not having access to some federal benefits.

To understand how the United States arrived at this point, it is crucial to recognise that the country faces a massive budget deficit of $2 trillion. This amount represents a doubling of the deficit from last year and is significantly higher than pre-COVID levels.

The primary reason for this deficit is that government revenues have remained at levels similar to those before pandemic, while spending has increased substantially. One notable factor contributing to this increase in spending is the rising cost of servicing the interest on the national debt.

It's worth noting that this potential government shutdown wouldn't be the first of its kind in the United States. In fact, there have been 14 government shutdowns since 1980, as reported by the Bipartisan Policy Center.

The most recent was a partial shutdown in 2018-19; it was also the longest, lasting 35 days. Historically, US government shutdowns have not had an impact on markets. And if one takes a look back at all those shutdowns, the average return has been 0 — essentially flat. There are a couple of reasons for that: one shutdowns are temporary, and two, any economic disruptions are also temporary. So government employees may not see pay cheques during a shutdown, but they receive back pay when things resume, so it all balances out.

If we zero-in on the three shutdowns which have been relatively more prolonged, the return has been net positive.

But there are implications which go beyond the equity price — for instance, important economic data releases.

Morgan Stanley compares the possible shutdown this time to the one in October 2013 as the dates — October 1-16 — line up nicely for the comparison.

Morgan Stanley  highlights how back then, the economic data release was delayed

In October 2013, the September CPI report was released on October 30, which was after a roughly two-week delay. This, in turn, pushed the release of the October CPI 2013 report because of September's processing backlog. The October CPI report was released on November 20, 2013 — three trading days late. Also, labour data was delayed. The September 2013 payroll report was released on October 22, six days after the shutdown ended. The October payroll report was released one week later than scheduled, on Friday, November 8.

So that’s one risk — economic data releases are crucial for the Federal Oen Market Committee (FOMC). If there's a shutdown this time, the FOMC meeting on scheduled for November 1 could be affected. If the shutdown persists, it could also could have a bearing on the US Federal Reserve's rate decision.  According to Goldman Sachs, however, a modest shutdown, in terms of duration, should have little effect on the Fed's monetary policy

A prolonged shutdown would add to the arguments in favour of postponing the November meeting and, finally, according to Moody’s, would be "negative’ for the US' debt rating". Moody’s, one must remember, is the last major rating agency which has yet to downgrade the United States' debt.