A US Federal Government Shutdown is Looming

Once again, the Democratic and Republican politicians find themselves in a political arm wrestle over the approval of the federal budget as bitter ideological divisions come to the fore. This is not an unknown phenomenon, as this current deadlock has appeared many times in the past. On the previous occasion, the ratings agency Fitch was moved to reduce the United States sovereign credit rating from AAA to AA+, citing financial mismanagement over the debt ceiling and fiscal incompetence over many years.

Congress is expected to vote to pass 12 appropriation bills that will finance government operations for the start of the new financial year at 12.01am on 1st October 2023, which means the politicians had until midnight on September 30th to iron out their differences. Currently these bills are caught up in the Republican controlled House of Representatives because of demands for deep spending cuts from right-wing congressional republicans also referred to as the far-right “Freedom Caucus”. The good news is that Congress agreed before the deadline to pass a bill officially called HR 5860 that prevents the government going into shutdown. However, this bill only gives enough money to keep the government open for 47 days and was signed into law by President Joe Biden just before the deadline on September 30th, 2023.

The Freedom Caucus is also at odds with their majority leader Kevin McCarthy for agreeing spending limits back in May of this year with the Democratic President Joe Biden, which they feel are far too generous and are in urgent need of pruning. In fact, any bill that is presented to the House is simply refuted by the Freedom Caucus, unless the House gives in to their demands. McCarthy has had five months to bring his rebellious right-wing to heel, but as can be seen by actions in the House, he has failed miserably. However, following a far-right Republican rebellion led by Matt Gaetz and seven Republican representatives and a handful of Democrats, a vote to remove speaker McCarthy was successful. The Freedom Caucus had been incensed for months as the speaker had been agreeing with Democratic spending plans and passing bill HR 5680 was the final straw.

The Republicans have decided to wait until 12th October 2023 before electing a new speaker, leaving the house rudderless for nearly two weeks, whilst in the meantime the 47 days are counting down to government shutdown. This is exactly the kind of behaviour as cited by the credit rating agencies as to why two out of three have already downgraded the United States’ sovereign credit rating to AA+. However, none of this matters to Congressman Gaetz and his cohorts, who, in their fervour to cut spending, may have single-handedly increased the cost of borrowing for the United States government.

Previous shutdowns have cost the government literally billions of dollars, as federal workers are sent home as the government grinds to a halt. The misconception is that a shutdown will save taxpayers money, where in reality there is back pay for the thousands of government workers that are sent home, lack of sales from government gift shops and uncollected entrance fees at national parks, to name but a few. The combined cost to the taxpayer for the last three government shutdowns was circa USD4 Billion where some 800,000 federal employees are sent home. In 2019 a report by the Senate Homeland Security and Government Affairs Committee on government shutdowns for 2014, 2018 and 2019 showed that out of circa USD4 Billion, that USD338 Million went on various fees, including administrative work, late fees on interest payments, while USD3.7 Billion was paid in back pay to those workers who were sent home.

There are many government departments and areas that are affected by a shutdown as listed below.

White House:
During the last shutdown the Whitehouse furloughed about 60% of their staff within the President’s Executive Office and, whilst the National Security Council continued to run normally, other areas such as the OMB, Office of Management and Budget found themselves working with a skeleton staff.

Agriculture:
Rural development, conservation and research programmes would be shut down, and some laboratory services would be closed making the fight against animal disease more difficult.

Small Business Support:
Loans for small businesses would halt as the Small Business Administration would stop operations except for those businesses hurt by natural disasters.

Labour Market:
Investigations into unfair pay practices would halt and safety inspections in the workplace would be severely curtailed.

Education:
Most Department of Education employees would be sent home for th duration which could mean disruption to student loans and Pell Grants*.

*Pell Grants – these are needed based federal grants/aid for students in post-secondary education or college and differ from student loans as they very rarely have to be repaid.

Economic Data:
According to the current administration the publication of major US economic data would be suspended, this would include inflation and employment data which is of major importance to investors and policy makers.

Health:
The CDC (Centre for Disease Control) would have over 50% of their workforce sent home though many public health activities would suffer though they would continue to monitor disease outbreaks.

Transportation:
Contingency plans for a shutdown allows for air traffic controllers to keep working, although history shows absenteeism could be a problem. Experts suggest that the travel sector alone will lose USD140 Million per day.

Science:
The National Science Foundation, the National Institutes of Health and the NOAA, (The National Oceanographic and Atmospheric Administration) would send home most of their staff curtailing scientific research.

Financial Regulation :
Out of its 4,600 staff The Securities and Exchange Commission would send home circa 90% with only a skeleton staff available to deal with emergencies. Furthermore, the CFTC (Commodities and Futures Trading Commission) would also send home most of their staff, thereby halting regulation, enforcement and oversight.

Social Security, Medicare and Other Benefits :
Circa seven million mothers who receive nutritional benefits via the Woman Infants and Children Programme would cease to receive such benefits. The Supplemental Nutrition Assistance Programme would continue to provide food benefits throughout October, but come November distribution could be affected.

Disaster Response :
There is the potential for FEMA (The Federal Emergency Management Agency) to run out of funding for long-term recovery projects and disaster relief.

Experts are also warning that a government shutdown would spook the financial markets with some analysts predicting that economic growth would be reduced by 0.2% for every week it lasted. However, it is important to note that history shows that government shutdowns are only very short-term and investors worrying about economic uncertainty should satisfy themselves that any shutdown will only be temporary.

Another investor worry is how will the US Treasury market (government bonds) fare under a shutdown? Taking a look at the Move Index*, historical data shows market volatility rose by 3.8% during the government shutdown of 1990 and rose by 7.2% during the government shutdown of 1995 – 1996. However, during the shutdowns of 2013 and 2018 – 2019 market volatility fell by 12.6% and 14.8% respectively.

*Move Index – is a market implied measure of bond market volatility. The calculation of implied volatility is based on US Treasury Options utilising a weighted average of option prices on Treasury Futures across multiple maturities being 2,5,10 and 30 years.

Historically, there has been a negative impact on US stock markets during government shutdowns which should calm any nerves of equity investors. In fact, data shows that the S&P 500 Index gained an average of 4.4% during such shutdowns. Experts suggest that investors should look for bargains in the healthcare and defence sectors, which depend greatly on contracts from the government. Such suggestions are due to the fact that both sectors are currently underperforming in the S&P 500 and buying opportunities may well present themselves in the event of a shutdown. Historical data show that since 1995, during shutdowns the defence sector and the healthcare sector advanced 5.2% and 2.3% respectively, and in the longer term both could benefit from government spending.

Out of the big three credit rating agencies, Standard and Poor’s*, Moody’s and Fitch, the only credit rating agency that still gives the United States a AAA Sovereign Credit Rating is Moody’s (Aaa equivalent). However, since Fitch downgraded the United States Sovereign Credit Rating from AAA to AA+ (1st August 2023) due to the debt ceiling crisis, Moody’s have announced that a government shutdown would negatively affect the country’s credit rating.

In early August 2011, Standard and Poor’s downgraded the United States Sovereign Credit Rating from AAA to AA+ which followed an acrimonious and bitter debate in congress regarding national debt. They went on to say that the budget deal that was brokered between the Republicans and the Democrats did not do enough to address the gloomy outlook for the US finances.

Moody’s analyst William Foster recently advised that current evidence shows political polarisation is making policymaking in Washington DC weaker due to higher interest rates putting pressure on government debt affordability. A government shutdown would further enhance this evidence. Mr Foster went on to say “If there is not an effective fiscal policy response to try and offset those pressures … then the likelihood of that having an increasingly negative impact on the credit profile will be there, and that could lead to a negative outlook, potentially a downgrade at some point, if those pressures are not addressed.

The upshot is that due to the usual political machinations, the United States may well lose their last coveted AAA sovereign rating, (Moody’s Aaa), and the country may perhaps look less creditworthy and could be looking at paying higher interest on their debt. Indeed, updated costs on the shutdown from experts estimate that the cost to the US economy could be in the region of USD6 Billion per week.

If bill HR 5860 had not been passed, the Federal Reserve would have had to fly blind without any data especially as employment and inflation data is due in early October, data that has an impact on interest rates. Thankfully, the Federal Reserve will receive this data, but once again the elected officials are doing their best to make it difficult for the unelected officials or experts to run the economy of the country, and do not think for one minute that a new Speaker of the House will bring the curtain down on continuing arguments over the federal budget. Matt Gaetz and his pals in the far right Freedom Caucus will continue to fight for spending cuts unless the Democrats at least begin to try and meet some of their demands.