Government Shutdown Risks: Impact on Economy and Markets
A looming government shutdown presents another potential headwind for a U.S. economy already grappling with rising inflation and a weakening labor market. The potential cessation of government operations, triggered by a Republican and Democratic impasse over health insurance subsidy extensions, raises concerns about potential economic disruption. If a deal isn’t reached by 12:01 a.m. Wednesday, hundreds of thousands of nonessential federal workers will be placed on furlough, while essential workers will continue their work without pay. Historically, government shutdowns have had limited lasting effects on the wider economy, with analysts estimating that even the longest shutdown – 35 days in 2018 and 2019 – shaved only 0.4% from total economic output.
The immediate impact will largely depend on the number of workers furloughed. In the 2013 shutdown, approximately 40% of all civilian employees were placed on furlough. A similar scenario could potentially slow U.S. economic growth by roughly 0.15% per week. The situation is particularly precarious as inflation has steadily increased since April, and the labor market displays signs of weakening. Recent Bureau of Labor Statistics data show that the U.S. economy created 911,000 fewer jobs than previously estimated, and August saw only 22,000 jobs added. Furthermore, June’s job growth was revised downward.
This shutdown also introduces uncertainty surrounding the next jobs report, slated for release Friday. The delay in its dissemination could complicate the Federal Reserve’s upcoming October rate decision, a decision already fraught with challenges. “There is no risk-free path,” Fed Chair Jerome Powell stated last week, emphasizing the persistent uncertainty regarding the trajectory of inflation. The central bank recently implemented its first interest rate cut of the year, but now must carefully balance the pressures of inflation with a slowing labor market. Typically, a central bank would raise rates to curb inflation while cutting rates to stimulate job creation – a delicate balancing act.
Markets have generally responded reasonably well to government shutdowns, exhibiting a tendency to remain stable. A study by Truist Wealth found that, on average, the S&P 500 experienced minimal changes across the 20 government shutdowns since 1976. In the long term, the S&P 500 has historically risen by approximately 12% within 12 months following shutdowns. However, the 2018-2019 shutdown presents an outlier. The S&P 500 saw a more than 10% rise during that period, although this was preceded by a significant sell-off driven by concerns about declining corporate earnings and the Federal Reserve’s interest rate hikes. Heading into the anticipated shutdown this week, the S&P 500 is up over 13% year-to-date, while the Nasdaq Composite has increased by 17% and the Dow Jones Industrial Average has climbed nearly 9%.
The Dollar Index—the value of the U.S. dollar relative to a basket of foreign currencies—often experiences fluctuations but rarely exhibits decisive movement during government shutdowns. U.S. Treasury bonds may occasionally rally due to increased demand for “safe haven” assets, but typically are largely unaffected by government closures in the long run. This year, the Dollar Index has declined nearly 10% primarily due to uncertainty surrounding the president’s sweeping tariff and trade agenda. Additionally, a government shutdown could raise questions about the U.S. credit rating. However, analysts at JPMorgan Chase contend that a shutdown would prevent the government from issuing debt, mitigating the likelihood of a credit downgrade, considering the “One Big Beautiful Bill Act” had already raised the debt ceiling. Nevertheless, major rating agencies have repeatedly cautioned about rising fiscal and budget risks, as Moody’s underscored in May. All three agencies believe the strength and resilience of the U.S. economy, coupled with independent monetary policy at the Federal Reserve, will largely persist despite occasional institutional pressures.
