US Government shutdown update

Highlights: The US government shut down at 12:01 a.m. ET on 1 October after Congress failed to pass new funding. A scenario of the shutdown lasting 10 days could lead to a 0.13 per cent impact on GDP and the delay in the publication of some economic data complicates matters for investors. Still, the market reaction has so far been mild as AI enthusiasm continues and the Fed should remain on its rate cut path

• The Senate blocked both parties’ stopgap bills: a Republican version funding through 21 Nov and a Democratic version funding through 31 Oct with healthcare provisions. Both failed to reach the 60 votes required. The main sticking point is whether to include ACA premium subsidies and Medicaid protections in the short-term bill. Federal agencies have activated shutdown contingency plans. Essential services (military, border security, Social Security checks, air traffic control) continue
• Each week of shutdown reduces quarterly GDP by about 0.1–0.2 per cent, and contractors may permanently lose income, according to the Congressional Budget Office. If this government shutdown were to go on for more than a few weeks, it would cut into current quarter GDP further, given the weakening labour market (as further illustrated by the weak ADP number)
• This has already increased the odds of Fed rate cut in October and December, with the market almost fully pricing in an October cut and an 89 per cent chance of a December cut thereafter. This is aligned with our view of two cuts by year end, leaving the Fed Fund’s rate in a range of 3.50-3.75 per cent
• For equity investors, the politics and uncertainty of a government shutdown have typically created volatility, and usually resulted in equity markets recalibrating. But this potential short-term weakness is usually overcome by the longer-term fundamentals, which remain positive. Moreover, historically, markets rebound after any initial weakness
• For fixed income investors, the uncertainty surrounding a government shutdown could raise risk premia and cause some mild yield curve steepening but that is offset by the negative impact of the shutdown on growth and any flight to quality. Amid markets’ continued belief in Fed rate cuts, Treasury volatility has so far remained in check
• Implications for the US dollar are mixed. In the short term, there could be some weakness, but given that these conflicts are usually resolved, rate differentials will remain the main driver for the medium term. We continue our policy of FX diversification, for example into EUR, AUD and SGD