Countdown To US Government Shutdown: How Could It Impact The Stock Market?

As the clock ticks down to a potential U.S. government shutdown, budget negotiations in Congress remain deadlocked.

A group of conservative and mainstream House Republicans has reportedly reached an agreement to fund the government through October via a continuing resolution. This deal faces resistance from some far-right House Freedom Caucus members, creating uncertainty on Capitol Hill.

The White House warned of dire consequences should a shutdown occur, citing potential damage to the economy, national security and overall uncertainty for families and businesses across the nation.

With only 11 days remaining before the shutdown deadline, the question on investors’ minds is: How would a government shutdown impact the stock market?

Read Also: 2 Major Sectors Will Likely Take The Hit If Government Shuts Down In October

Economic Impact of a U.S. Government Shutdown

Congress must pass a budget to fund the government for fiscal year 2024, which begins on Oct. 1.

Goldman Sachs’ economist Jan Hatzius predicts the federal government is increasingly likely to experience a temporary shutdown. In such an event, only discretionary spending, which constitutes approximately a quarter of federal outlays, would be affected, as mandatory spending on programs such as Medicare and Social Security operate automatically under congressional rules.

It’s worth noting government shutdowns primarily affect federal employees (making up about 2% of GDP), with minimal impact on investment or purchases of goods and services.

Approximately 65% of federal employees would continue working during a shutdown, as their services are deemed essential. According to Goldman Sachs, a government-wide shutdown could reduce quarterly annualized growth by around 0.2 percentage points for each week it persists, assuming modest private sector effects. The baseline projection suggests a shutdown lasting two to three weeks.

Bank of America’s economist Michael Gapen draws parallels to the situation in 2011 when Congress had to pass funding bills even after the Budget Control Act lifted the debt ceiling. While it took several continuing resolutions and negotiations, a budget deal was eventually reached.

In the grand scheme, government shutdowns are generally less painful than defaults, with full shutdowns trimming only about 0.1 percentage point off weekly growth.

Market Reaction To Past Government Shutdowns

Historically, financial markets have not exhibited significant reactions during government shutdowns.

Surprisingly, their average returns were above average in the year following a shutdown.

The S&P 500 recorded returns of 12% on average 12 months after the end of a shutdown, with nearly 86% of these periods yielding positive returns, as Ryan Detrick, CMT, showed on X.

One remarkable instance was the second shutdown during the Ronald Reagan administration, which lasted only 3 days in 1982. In the 12 months following that brief shutdown, the S&P 500, tracked by the SPDR S&P 500 ETF Trust SPY, saw an impressive 36% return.

Even in the most recent and prolonged government shutdown, occurring from Dec. 22, 2018, to Jan. 25, 2019, during the Donald Trump administration, the S&P 500 managed to rise by 10% over that period. In the subsequent 12 months, it added a remarkable 23.7% return.

Now Read: Fed Decision Looms: Will Steady Rates Prevail Despite Inflation Pressures?