How shutdowns impact stocks and bonds

A government shutdown occurs when Congress fails to pass a budget, leading to a temporary funding lapse. While essential services continue, many government operations pause, federal workers may be furloughed, and data releases, permits, and loan approvals can be delayed. Importantly, a shutdown does not mean a default on debt, and financial markets remain open. Past shutdowns have shown varied market impacts, with stocks often showing positive performance after an initial dip, and long-term Treasury yields tending to decrease in the months following a shutdown.

The video analyzes the market effects of US government shutdowns since 1980, examining stock market performance and bond yields. Historically, stock markets tend to be relatively flat around the start of a shutdown, with positive returns emerging one to three months later. Long-term bond yields have shown a median drop of 19 basis points one month after a shutdown begins, occurring in nine out of eleven instances. Short-term rates are more volatile but tend to decrease about a year later.

Key factors to monitor include the path of continuing resolutions, the duration of the shutdown, and potential delays in economic data. Longer shutdowns can negatively impact growth expectations and push long-term rates lower. Spillover effects can also affect federal contracts, small business loans, and travel. Ultimately, while shutdowns are often politically charged, their market impact is typically muted unless they are prolonged.

• A government shutdown is a temporary funding lapse resulting from Congress missing a budget deadline.
• Essential services, law enforcement, transportation, and Social Security payments continue, but many other federal operations pause, and workers may be furloughed.
• Since 1980, stock markets have generally shown flat performance around the start of shutdowns, with positive returns emerging one to three months later.
• Long-term Treasury yields have historically seen a median drop of 19 basis points one month after a shutdown begins.
• Key factors to watch include the length of the shutdown, the possibility of continuing resolutions, data delays, and potential spillover effects on federal contracts and loans.

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Understanding Government Shutdowns [0:14]

• A shutdown occurs when Congress misses a budget deadline or a short-term fix.
• Essential services continue, but many other government operations pause.
• Most federal workers are temporarily let go or furloughed.
• A shutdown is a temporary funding lapse.
• It slows some services and can delay data releases, like the monthly jobs report.
• Federal permits and loan approvals can also be delayed.
• A shutdown is not a government default on debt.
• Stock and bond markets do not close.
• Essential services such as law enforcement, transportation, and Social Security payments continue.
• It can cause inconveniences but is not the end of the world.

This section defines a government shutdown, clarifying what it is and, crucially, what it is not, to alleviate investor concerns. It highlights that while some services and operations are paused, core functions and financial markets remain unaffected.

"It's not the end of the world, but it can cause inconveniences."

Market Impact of Past Shutdowns [1:11]

• The video examines the market impact of 11 US shutdowns since 1980, using the S&P 500 as a stock market measure.
• Each bar on the chart represents the median return for different time periods: the week prior, the day prior, and one day, one week, 1 to 3 months, and one year after the shutdown.
• Median returns are generally small for shorter timeframes, except for around a month after.
• There were some significant downside reactions leading into the week of shutdowns in 1982, 1984, and 2018.
• Shorter time frames do not produce clear trends.
• Even in the 2018 shutdown, which lasted over a month, stocks were positive after a short initial drop.
• Markets tend to look past the "noise" once funding headlines fade.

This part delves into the historical performance of the stock market during and after government shutdowns, suggesting that markets often recover and show positive trends in the medium term.

"Translation markets tend to look past the noise once the funding headlines fade."

Impact on Bond Markets [2:09]

• The video analyzes the US 10-year Treasury note yield, which influences mortgage rates.
• Similar to stocks, when all results are combined and the median is taken, there are no big changes in the week prior to the week after a shutdown.
• There were significant outliers in many years, meaning bond yields did react, but there isn't a predictable historical pattern across the entire set of shutdowns.
• Looking one, two, and three months after the shutdown, consistent drops in long-term yields are observed.
• In nine out of 11 times, rates dropped one month after the shutdown started, with a median drop of 19 basis points (about 2/10ths of a percent).

This section focuses on the behavior of long-term bond yields, indicating a historical tendency for these rates to decrease in the months following a shutdown event.

"But once you start looking one, two, three months after the drop, you see consistent drops in long-term yield."

Short-Term Rates and Overall Market Trends [2:51]

• The analysis also looks at short-term movements in US rates, which are more influenced by Federal Reserve policy.
• There are many big and small moves, both up and down, from one week prior to three months after a shutdown, which don't produce big trends.
• However, one year later, there are drops in short-term rates about two-thirds of the time, with a median drop of 39 basis points.
• Stocks tend to be flat around the start of shutdowns and then climb higher one to three months out.
• Long-term yields tend to drift lower over one to three months.
• Short-term rates are mixed until they skew lower at about the one-year mark.

This part addresses short-term interest rates and then consolidates the findings for stocks and bonds, offering a general outlook on market movements following a shutdown.

"Stocks tend to be flat around the start of shutdowns. Then they climb higher one to three months out."

Key Factors to Watch [3:37]

• Continuing Resolution Path: This is the quick way to avoid or end a shutdown.
• Length Matters: The longer the standoff, the more it can negatively impact growth expectations and pull long-term rates even lower.
• Data Delays: If economic reports are delayed, markets will rely more on data from non-government sources.
• Spillover Effects: Federal contracts, small business loans, and areas like travel and parks can all be affected by the stoppage.

This concluding section outlines the critical elements investors should monitor during a government shutdown, emphasizing the impact of its duration and potential broader economic repercussions.

"Wrapping it up, shutdowns are politics loud and markets quiet unless they last."