Potential Government Shutdown in Fall 2023 Raises Market Concerns

Budget negotiations for funding the U.S. government in the fall of 2023 are anticipated to trigger a government shutdown in October, similar to the recent debt ceiling debate. Political gridlock resulting from the 2022 midterms, with a Republican-controlled House and Democratic-controlled Senate and Presidency, has led to this situation. While a government shutdown can impact economic growth, the historical effect on the markets has been relatively limited.

One of the reasons for the limited market impact is the historical brevity of government shutdowns, with most lasting three days or less. The longest shutdown on record, which was a partial shutdown, lasted 35 days. Furthermore, the introduction of legislation ensuring backpay for unpaid government employees has helped alleviate some of the consequences. However, recent trends show that shutdowns have been lasting longer, with two of the three longest shutdowns occurring in the past decade.

A government shutdown selectively affects certain functions of the government, as determined by the Office of Management and Budget. Essential services like hospitals, law enforcement, the active military, power grid coordination, the IRS, air traffic control, and parts of the legal system remain operational. Programs such as Social Security, Medicare, and Medicaid are also unaffected. Despite these exemptions, a shutdown disrupts government operations and may lead to economic disarray. Roughly one-third of government employees, around 800,000 individuals, have historically been furloughed or required to work without pay during a shutdown. It is worth noting that these employees will receive backpay once the shutdown concludes, but the impact on government contractors cannot be overlooked, particularly in defense and healthcare sectors.

Although the government continues to function in select areas during a shutdown, the effects are far from business as usual. Extended shutdowns can exacerbate disruptions, resulting in the suspension of new government loans, reduced services in National Parks, longer security lines at airports, and the halting of government research and statistical reporting. Paradoxically, the pause in statistical reporting makes it challenging for economists to accurately measure the shutdown’s impact on the economy.

Historically, government shutdowns have had a limited impact on the markets. However, the duration of the shutdown plays a crucial role in determining its market effects. The financial stress faced by unpaid government employees may impact consumer confidence, particularly among those living paycheck to paycheck. Additionally, businesses in the defense sector and those heavily reliant on government contracts may experience temporary disruptions depending on the nature of their agreements.

As fall approaches, the risk of a government shutdown in 2023 looms, although there is a possibility that the government will pass a budget or Continuing Resolution to avert such an outcome. Ultimately, the market impact of any potential shutdown will likely depend on its duration rather than its occurrence. While certain sectors and firms may experience disruptions, historical data suggests that the broader market impact tends to be mild.