US government may be headed for a shutdown Tuesday at midnight. Polymarket currently places >65% odds of a shutdown by October 1. We believe it is useful to review how prior shutdowns have impacted the economy and financial market participants. Given that no appropriations bills have been passed at the time of publication, a shutdown next week would likely involve all non-essential federal employees, making the 2013 episode a useful parallel. However, unlike 2013, this latest Congressional impasse over appropriations does not coincide with a debt-limit issue. Most important for market participants would be delays to economic data releases from the BEA and BLS ( Sep NFP data release on 3rd Oct might be the first casualty). This was also a feature of the 2013 shutdown as both the September and October employment and CPI releases were rescheduled. The economic effects of federal government shutdowns are modest. A full shutdown, which is what we are facing today, would be a drag of about 0.13pp of GDP growth per week, on our estimates. The jobless claims data, along with other private sector releases such as the ADP survey will become increasingly important for Fed officials in the event of a protracted shutdown—particularly, as they gauge the risks to the labor market ahead of the October 29 FOMC meeting. On the margin, we think a government shutdown may only increase the likelihood of an October cut, but only marginally. Our reasoning is that insurance cuts (as Fed Chair Powell said in his press con post Sep FOMC) don’t come in single cuts, they have to be a minimum two to act as insurance. A government shutdown only increases the employment mandate risk marginally. Hence October cut probability goes up slightly if full shutdown happens. Oct cut is currently priced at 22bps (as seen above) which can go to full 25 bps as the shutdown happens. One potential consequence from the government shutdown will be further reduction in force (RIF) during the shutdown. The Office of Management and Budget has instructed agencies to pursue further headcount reduction if funding lapses, which would lead to a more material and persistent drag on economic activity. US government shutdowns typically have very small impacts on US rates & curve shape. The rate impact could be larger if there were to be more meaningful drags to market sentiment or any material risk-off. Government shutdown risks typically don't have a clear directional impact on the USD. At a high level, they present opposing theoretical forces of: (1) potential marginal growth drag in the US (negative USD factor), against the potential for broader uncertainty and risk appetite concerns (positive USD factor). The FX market generally presumes that eventually there will be a political resolution.The S&P 500 and VIX typically have a muted response, though a notable exception was late 2018/early 2019 but that was more because of a hawkish FOMC Dec'18 meeting. Money markets are not directly impacted by a government shutdown & we expect the financial plumbing to operate orderly.
