The U.S. federal government began a partial shutdown this week. While notable, the impact of these shutdowns on the economy and financial markets have typically been modest. Political developments such as these often generate headlines and can induce some short-term volatility, but history suggests their impact tends to be transitory.

 

What’s going on?

 

Funding covering roughly a quarter of the budget for the U.S. federal government expired on October 1^st, causing a partial shutdown that will disrupt a range of government services and the furlough of many federal workers. This is a storyline we’ve seen before, as partisan divisions once again drove a standoff over a budget agreement. Republicans are pursuing a narrower spending bill, while Democrats are seeking an extension of healthcare subsidies and a reversal of recent cuts to healthcare programs. Negotiations are reportedly ongoing, but it’s difficult to gauge what a final resolution will look like or when one will arrive.

 

Importantly, not all federal services “shut down”. Essential operations, including Treasury payments and mandatory spending programs like Social Security, continue uninterrupted. Federal workers, however, are typically placed on temporary leave and receive backpay when government financing is restored.

 

Economic and market implications

 

U.S. government shutdowns vary in length, often producing some near-term turbulence. Historical episodes show that U.S. stocks tend to weaken just before, during, and shortly after it ends. However, because most shutdowns do not last very long, the equity market impact is typically short-lived, with stocks usually regaining lost ground soon thereafter.

 

For the economy, U.S. government shutdowns can temporarily weigh on growth, but they have historically not been significant enough to derail ongoing expansions. The economy typically recovered briskly after a resolution. However, this shutdown comes at a more delicate time. The U.S. labour market has recently shown signs of softness, and President Trump’s proposed plans to dismiss federal workers during the shutdown add another layer of uncertainty. Moreover, the suspension of key economic reports, such as the monthly employment report, makes it harder for both policymakers and investors to assess economic conditions. Notably, the delay of major economic data makes the job of the U.S. central bank more challenging in the near-term as policymakers evaluate whether further interest rate cuts are warranted to support the economy.

 

Canadian roundup

 

North of the border, recent data suggests the Canadian economy is holding up despite persistent trade-related disruptions that have weighed on exports, business investment, and overall growth. Canadian GDP rebounded in July from a spell of recent weakness and RBC Economics now forecasts a modest expansion in the third quarter. Sentiment has also perked up, with strong equity market performance helping to lift household net worth in the second quarter, while softening home prices and lower interest rates have eased housing affordability pressures.

 

Takeaway

 

U.S. government shutdowns are not unusual. There have been 20 such episodes since 1976, according to RBC Economics, with most of them resolved in under ten days. While they can create short-term downside volatility, they have generally not been meaningful drivers for financial markets or the economy.

 

Have a great weekend.

 

Tim