To judge by recent history, a US government shutdown won’t be a huge event for the bond market. If anything, it could even provide a little short-term relief, since Treasuries usually rally when investors need somewhere to hide.
(Bloomberg) — To judge by recent history, a US government shutdown won’t be a huge event for the bond market. If anything, it could even provide a little short-term relief, since Treasuries usually rally when investors need somewhere to hide.
But it’s also adding a big dose of what financial markets hate the most: uncertainty.
Less than four months after resolving a standoff over the debt limit that threatened to push the US into default, the dysfunction in Washington is taking center stage on Wall Street again. And that’s complicating the lives of analysts and investors already trying to gauge the Federal Reserve’s interest-rate path as the US economy defies gloomy forecasts, inflation remains stubbornly elevated and growth sputters elsewhere around the world.
“Investors will definitely see this as a near-term market event risk that creates volatility,” said Jean Boivin, a former Bank of Canada official who now heads the BlackRock Investment Institute.
It’s possible that lawmakers could still pass legislation to keep the government running after the new fiscal year starts on October 1. Moreover, the stakes aren’t as high for markets as they were during the fight over the debt limit earlier this year because it won’t affect the Treasury Department’s ability to cover its bond payments.
Yet that doesn’t mean it won’t be consequential. A shutdown could muddy the outlook if it delays the release of key data reports — like the monthly employment and inflation figures due in the first half of October — or if it slows the economy as government workers go unpaid. It would also underscore the political unpredictability that’s already driven Fitch Ratings and S&P Global Ratings to strip the US of their top grades. Moody’s Investors Service, which still has the US at Aaa, on Monday signaled its confidence is wavering, too.
“We could have a government shutdown and that will likely lead to some heightened uncertainty,” Michael Pond, the head of global inflation-linked research at Barclays, said on Bloomberg Television.
During past government shutdowns, that’s been positive for Treasury bonds because they remain the go-to haven for investors. As analysts from Well Fargo noted, yields on 2- and 10-year Treasuries fell during the shutdowns in 1995, 2013 and the end of 2018.
This time around, that could take some of the short-term pressure off the market. Yields have risen since the Fed last week indicated that rates are likely to remain high well into next year as the economy exhibits surprising strength. The selloff continued Monday, when 30-year yields rose as much as 15 basis points to 4.67%, the highest since 2011.
While most economists expect only a modest impact from a shutdown, it comes amid a widening autoworker strike and the end of a federal reprieve from student-loan payments. Combined, the three could reduce the pace of the economy’s growth to 1.3% in the final three months of the year from an estimated 3.1% in the third quarter, according to Goldman Sachs Group Inc.
Already, futures traders have pushed out the anticipated timing of when the Fed may enact its next and final rate hike from November to January.
Gennadiy Goldberg and Molly McGown of TD Securities said in a note to clients that they expect a shutdown to buoy Treasuries, particularly shorter-term ones, by sapping risk-taking sentiment. “Overall, we view the shutdown as one of the many headwinds the economy faces this fall,” they wrote.
Longer term, a shutdown may cast another negative shadow over the Treasury market. It would be the fourth time in the last 10 years that the federal government has had to take that step, highlighting the increasingly polarized politics that’s affecting even routine functions and undermining Wall Street’s confidence.
Last month, Fitch stripped the US of its top rating, citing the nation’s growing debt burden and the erosion of governance that has “manifested in repeated debt limit standoffs and last-minute resolutions.”
Fitch’s step, which followed a similar move by S&P in 2011, contributed to the subsequent pressure on long-term Treasuries, which have also been hit hard by rising interest rates and a flood of new debt sales to cover the deficit.
BlackRock’s Boivin agreed that a shutdown may deliver a short-term gain to some corners of the Treasury market as investors use it as a temporary haven.
“But the risk on the fiscal side could worry investors and over time there is more term premium,” he said, referring to the extra yield investors usually demand for holding long-dated securities. “If you are worried about the fiscal outlook you don’t run into US Treasuries.”
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