Will a Government Shutdown Hurt Stocks?

Stocks traded for a small loss this morning as Treasury yields jumped. An awful 2-year Treasury auction caused the 2-year Treasury yield to soar to a 19-month high of 0.286%. The 10-year Treasury yield spiked as well, briefly climbing above 1.50%. It’s a clear sign that investors are concerned about the Fed tapering its bond-buying programs.

With a 5-year Treasury auction set for later today, yields could zoom even higher if that also goes poorly. The 2-year Treasury auction was stunningly bad, relatively speaking. The bid-to-cover ratio – the dollar amount of bids received in a Treasury security auction versus the amount sold – plunged from 2.649 in August to 2.27 in September.

The last time that ratio was this low for 2-year Treasurys, Lehman Brothers had just collapsed three months prior (December 2008).

Overall, this morning’s dismal Treasury auction indicated a major lack of buyers. That trend may continue as economic optimism and inflation push rates to higher highs.

“We believe that these [bond market] moves have provided the spark for another ‘Value Rip’ across equity markets. In our view, the direction of longer-term interest rates should remain the #1 driver of market returns, sector rotation & thematic performance in the weeks ahead,” explained Wolfe Research’s Chris Senyek in a note to clients.

Today, that’s certainly been the case. The Dow is up while the tech-heavy Nasdaq Composite is down.

Among the biggest losers of the morning were the Big Tech elite. Apple (NASDAQ: AAPL) and Google-parent Alphabet (NASDAQ: GOOG) both sunk over 1%.

Gridlock in Washington is also threatening to send stocks lower once more. Congress is set to vote on a new budget, $1 trillion bipartisan infrastructure bill, and raising of the debt ceiling this week. House Speaker Nancy Pelosi expressed that all three should pass with ease. But concerns over whether that’s true are beginning to weigh on bulls.

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“DC will start garnering more attention in the coming weeks as the political calculus around passing infrastructure bills and the debt ceiling debate likely guarantees some market-moving headlines,” said Raymond James strategist Tavis McCourt.

Lawmakers need to raise the debt ceiling to avoid a government shutdown. And they would do it willingly under normal circumstances.

But Republicans have taken issue with Democrats who decided to tie the debt ceiling vote to the federal budget. Significant uncertainty over the lifting of the debt ceiling has emerged as a result.

“Speaker Pelosi and Senate Schumer announced that they will move forward with legislation that ties an extension of government spending authority to a suspension of the debt limit. Our political economist believes that the likelihood of a government shutdown increases the longer Democrats pursue this course,” wrote David Kostin, Goldman Sachs chief U.S. equity strategist, wrote in a note.

The average government shutdown goes barely over a week:  Eight days to be precise. Most traders have been through a few government shutdowns in their day and have learned to ignore the antics coming out of Washington.

The longer the shutdown goes on, the greater the chance of a steeper drop. But just for reference, the longest shutdown ever was under Clinton in 95-96, lasting 21 days, and the market went up .1%.

Since 1982, 75% of government shutdowns have actually had a positive effect on the market. Almost 75% of government shutdowns since 1982 have seen gains to the S&P anywhere from 0.1% to 3.1%.

One week of shutdown equals negative .1% to GDP growth. That’s according to a 2014 Congressional Research Service report. If we assume the trend holds and a shutdown lasts a week or even just a few days, the impact is negligible to the economy and investors.

Government shutdowns haven’t had a truly negative impact on the markets since the Carter administration, and it’s hard to say whether the shutdowns had an effect back then, either, considering just how bad those years were for stocks in general.

For now, it’s steady as she goes until a shutdown is confirmed. And if a shutdown does happen, investors should be on the watch for anything lasting longer than 3 weeks. In the past that’s been a good indicator to reassess your risk and prepare for a more entrenched, long-term shutdown. But as history tells us, it’s very unlikely.

Especially with a cash-starved Treasury itching to issue hundreds of billions in new debt.

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