How could a potential U.S. government shutdown impact markets and the economy?
- Markets are unlikely to experience material impacts from a U.S. government shutdown
- Rising oil prices could dent U.S. economic growth in Q4
- The spike in U.S. Treasury yields was one of the main themes from the third quarter
On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, discussed the potential impacts of several challenges facing the U.S. economy, including the strike by the United Auto Workers (UAW) union and a possible federal government shutdown. With the third quarter wrapping up, he also reviewed key market themes from the July through September period.
What are the potential threats to U.S. Q4 economic growth?
Eitelman kicked off the segment by noting that there are currently four headlines that investors worry could have impacts on the U.S. economy in the near-term: the UAW union strike, a potential shutdown of the federal government, the resumption of student loan interest payments and higher oil prices.
Starting with the UAW strike, which began 15 September, Eitelman said that the work stoppage is unlikely to have any significant impacts on U.S. economic growth. He explained that union membership in the U.S. is half of what it was during the 1980s inflation episode, and that the striking auto workers make up only 0.1% of private employment. Noting that the UAW union is calling for a 30% increase in wages, Eitelman said that such an increase would have essentially no impact on aggregate wage inflation data. "It would be a rounding error that would net out to zero in the broader picture," he said.
As for the impacts of a U.S. government shutdown, Eitelman said that if the federal government were to close, markets would probably not experience any material impacts. "There have been six government shutdowns in the U.S. in the last 35 years, and investors have become hardened to them," he remarked, noting that markets now understand how government closures tend to play out. For example, federal government workers typically are not paid during a shutdown, but receive back pay from the U.S. Congress once the shutdown ends, Eitelman explained. The net result, he said, is that government shutdowns typically leave no lasting imprint on the economy or markets.
However, a prolonged shutdown could potentially alter what steps the U.S. Federal Reserve (Fed) takes at its 31 October to 1 November policy meeting, Eitelman said. This is because the U.S. government would stop publishing economic data during a shutdown including its monthly nonfarm payrolls and CPI (consumer price index) reports, he explained. "The Fed has emphasised that any adjustments to monetary policy will be data-dependent, and if a shutdown were to drag on, the Fed wouldn't have access to either of these reports. If this happens, I think the central bank would be inclined to hold rates steady in November," Eitelman noted.
Turning to U.S. oil prices, which recently hit their highest level since August of 2022, Eitelman said the higher costs will likely dampen both consumer spending and consumer confidence. "I'd estimate that if oil prices stay at these levels, they'll probably shave 0.5% off of fourth-quarter GDP (gross domestic product) growth," he said. Eitelman emphasised, however, that the overall shock to commodities markets is currently nowhere near as significant as it was in early 2022, when Russia invaded Ukraine. "Back then, oil, natural gas and wheat prices all spiked at the same time. The overall impact here so far has been notably smaller," Eitelman remarked.
He said that the last of the four potential economic disruptors the resumption of student loan interest payments on 1 October could also have an impact in the short term. The payments might knock off another 0.5% from Q4 growth, Eitelman said.
Altogether, the combined impacts of the UAW union strike, a potential government shutdown, higher oil prices and the resumption of student loan payments will likely create a pothole for the economy in Q4, Eitelman said, with growth stumbling. "It does look like the U.S. economy performed very well in the third quarter probably expanding at a 3% annualised clip. In the fourth quarter, given the potential economic disruptors, a 1% growth rate would be a good outcome," he stated.
Key market themes from Q3
Eitelman concluded the segment with a look at key market themes from the third quarter, which ends 30 September. The main takeaway, he said, was that the July to September period was marked by a sharp rise in U.S. Treasury yields, with the yield on the benchmark 10-year note climbing roughly 80 basis points during the third quarter.
The spike in yields led to pain in stocks, Eitelman said, noting that almost every major regional equity market is on track to finish the third quarter down by 3% or more on a U.S. dollar basis. "Energy-sector equities and Japanese equities were really the only places to hide in Q3," he noted.
As for what may lie ahead for the rest of the year and into 2024, Eitelman said he and the team of Russell Investments strategists remain slightly cautious on the outlook, given expensive valuations and business cycle headwinds. "We think a mild recession before the end of 2024 is the most likely outcome, although a soft-landing scenario is possible," he concluded, noting that the team's updated views on economies and markets are now available in Russel Investments' just-released Q4 Global Market Outlook.