Could a U.S. government shutdown hurt the economy?

On the latest edition of Market Week in Review, Consulting Director Sophie Antal Gilbert and Senior Investment Strategist Paul Eitelman discussed the potential effects of a U.S. government shutdown on financial markets and the nation’s economy.

Economic and market impacts of possible government closure in U.S.

In order to avoid a shutdown, the U.S. government needs to pass a new budget deal by the end of the day on Jan. 19, Eitelman said—and that’s looking less likely. If the government does close, many federal employees will temporarily stop receiving their paychecks, he said—dampening income in the short run and potentially hurting the nation’s overall gross domestic product (GDP) growth rate. “Historically, for each week the federal government is closed, two-tenths of a percentage point can be shaved off the country’s GDP growth during the quarter of the shutdown,” he explained. Just as important, though, Eitelman said, is the fact that once the government re-opens, federal workers receive back pay for the time they missed—meaning that GDP growth typically rebounds in the following quarter.

“Because of this, financial markets tend to treat U.S. government shutdowns as simply noise—and not a signal for something that will fundamentally alter the course of the economy,” he stated. That said, there is a risk that if a shutdown does occur and drags on long enough, it could coincide with the federal government’s debt-ceiling deadline in March. “If this happens, there’s the potential risk of the Treasury Department having to technically default on its bonds—which would be a much bigger deal,” Eitelman said, adding that bond markets appear to already be pricing in the risk.

Another week, another rise in U.S. Treasury yields

Yields on the 10-year U.S. Treasury note continued to climb the week of Jan. 15, Eitelman said, surpassing 2.6% on Jan. 19—with some of this likely due to the increasing tension around the potential for a federal government shutdown as well as the debt-ceiling debate. However, he believes there are probably two bigger factors at play. The first? The year-long environment of strong global growth, which in Eitelman’s opinion is probably causing investors to start thinking about rotating into riskier asset classes, like equity markets. The second? The U.S. Federal Reserve (the Fed)’s recently-released Beige Book report, which showed a bit more evidence that inflationary pressures are starting to bubble to the surface in the U.S.

“The report pointed to a very tight labor market, with modest to moderate wage and price increases,” Eitelman said—“and I think this shows that, at the margin, the inflation story could also be a threat to bonds.”

Solid growth numbers in Europe: What could it mean for earnings growth in 2018?

Shifting to Europe, Eitelman noted that European equities—as measured by the STOXX® Europe 600 index—performed strongly the week of Jan. 15. “This is solid evidence that we’re in the prime stage of the market cycle for Europe,” he remarked, adding that growth numbers across the eurozone have been outstanding. “Given the strong fundamentals in this region, our team of strategists at Russell Investments believes European businesses could generate roughly 10% earnings growth this year,” he said.

On the other side of the coin, inflation across the eurozone slowed to 1.4%, year-over-year, in December, Eitelman said—down from 1.5% in November, per newly-released data from Eurostat. This means there’s not a lot of pressure for the European Central Bank (the ECB) to start thinking about raising interest rates, Eitelman said—which, in his view, helps create an optimal situation for equity markets. “The fundamentals are there for a continuation of strong corporate growth, without a lot of risk from the interest rate side,” he concluded.

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