Staying the course during a government shutdown

Congress remains at a stalemate over an agreement to fund the U.S. federal government for the next fiscal year (which begins October 1); a partial shutdown of the government appears likely if lawmakers can’t reach a deal by midnight on September 30. Investors may have questions about how a shutdown could affect markets. If past history is any guide, there is no clear relationship between government shutdowns and market returns, and investors would be wise to tune out the noise and stick with their long-term investment plan.

Different from the debt ceiling debate

It’s important to understand that the current negotiations to keep the government fully operational are completely different from the debate over whether to raise the debt ceiling that took place earlier this year. In the case of the debt ceiling talks, the biggest risk was a potential U.S. default if lawmakers did not raise the debt ceiling. Defaulting occurs when the U.S. Treasury has insufficient resources to satisfy the government’s obligations. A default has never happened and would have significant ramifications for U.S. creditworthiness, in addition to spillover effects on the global financial system.

A shutdown occurs when the federal government suspends services deemed non-essential because a new law to fund discretionary spending programs was not approved ahead of a fiscal year deadline. When agreement on a new funding bill is not reached, Congress may pass a “continuing resolution” that extends previous funding levels to keep the government fully operating.

Past government shutdowns paused nonessential activities in various government departments—for example, national parks and museums have closed. Critical federal government functions such as ongoing Social Security benefits, air traffic controllers, and the Postal Service generally were not affected. This can vary across shutdowns, and each government agency will put out guidance clearly defining the scope of their activities. Federal government shutdowns don’t affect state and local government functions that are not dependent on federal funding.

Shutdowns have occurred more than 20 times since 1976. Unlike a default, a shutdown does not affect the government’s ability to pay its obligations, and, as noted, many critical government services continue.

Shutdown: A history of mixed results for markets and the economy

Although there can be market volatility during a shutdown, history reveals no clear relationship between shutdowns and market returns. Markets might experience heightened volatility in response to the uncertainty in Washington. However, markets have historically had mixed reactions to government shutdowns, with equities finishing in positive territory more than half the time (as noted in the accompanying chart). In the seven instances where shutdowns have lasted 10 days or more, the Standard & Poor’s 500 Index fell four times within the shutdown period and rose three times. The worst return, –4.4%, came during an 11-day shutdown in 1979.

The results are similar for fixed income securities as bond market activity surrounding U.S. government shutdowns since 1976 shows an even split between positive and negative returns for fixed income.¹

The economic effects of a shutdown depend largely on its duration. The Congressional Budget Office (CBO) estimated that the 2018-2019 shutdown, the longest on record, shaved 0.1% off real GDP in the fourth quarter of 2018 and 0.2% in the first quarter of 2019. The shutdown dampened economic activity mainly because of the loss of furloughed federal workers’ contribution to GDP, the delay in federal spending on goods and services, and the reduction in aggregate demand (which then dampened private-sector activity).

Why you should stay focused on long-term results

A government shutdown is only one of many factors, both positive and negative, that affect markets. Because there are so many variables, the effects cannot be accurately predicted.

Political divisions in Washington have made the threat of government shutdowns more common in recent years. Although this is not an ideal practice and a prolonged shutdown could have broader short-term market and economic effects, what’s most important is that investors remain disciplined, diversified, and patient during such an event.

1 Bloomberg and Vanguard analysis.

Notes:

All investing is subject to risk, including the possible loss of principal.

Diversification does not ensure a profit or protect against a loss.