(Bloomberg) — Global investors are bracing for the fallout from the US government’s latest shutdown after Congress failed to reach an agreement on funding operations.
US equity futures declined and the Bloomberg dollar spot index fell 0.1% after the midnight funding deadline came and went, triggering the US government’s first shutdown in nearly seven years. The White House’s budget office ordered agencies to begin executing plans to halt all but essential duties, disrupting the jobs of hundreds of thousands of Americans and upending many public services.
Investors have been basing their expectations on past shutdowns, where bouts of political posturing quickly gave way to resolutions that avoided lasting economic damage. Wall Street has largely ignored them.
But the wrangling among Congressional leaders seems more pointed this time, raising the potential for a protracted standoff that could damage the world’s largest economy. The Trump administration’s promise to carry out mass firings of federal workers, rather than furloughing them, would send jobless claims rising when employment already looks fragile.
The main macro implications lie in the labor market and predictions for the path of interest rates. Government data will go dark. This week alone that would mean no readings on jobless claims, factory orders and September’s hiring report — key elements for Wall Street to chart expectations for growth and the path of interest rates.
“This shutdown could have bigger implications than usual because the stakes have been raised so high even before the event,” said Steve Sosnick, chief strategist at Interactive Brokers.
Nasdaq 100 futures fell 1% by 3:15 a.m. in New York on Wednesday while S&P 500 contracts slipped 0.8%. The US yield curve steepened slightly as long-dated bonds weakened. The 10-year yield was one basis point higher at 4.16%, while shorter-dated notes were steady. The Cboe Volatility Index jumped as high as 17.28 points.
Another complicating factor is the equity market’s extended bull run has pushed valuations to levels associated with past bouts of euphoria. With volatility subdued and traders positioned to take advantage of any year-end rally, any wobble in asset prices could lead to forced selling that would exacerbate a downturn.
If the impasse drags on, analysts expect gold to retain its allure as a haven, even after pushing to an all-time high near $4,000. Part of the rise owes to weakness in the dollar, which has retreated in past shutdowns. A further drop in the dollar could bode well for the Japanese yen, and possibly the euro, according to ING Bank. Long-dated Treasuries have benefited from prior shutdowns, presumably on bets for economic weakness.
“Coupon and debt service payments are not at risk,” Monica Guerra, head of US policy at Morgan Stanley Wealth Management, wrote in a note Tuesday. “Given high yields, US Treasuries remain attractive, and we encourage investors sensitive to government shutdown risk to opt for increased US Treasury exposure.”
For those who want to stay active in the stock market, here’s what to watch for under the hood.
Defense
Defense contractors, including RTX Corp., L3Harris Technologies Inc. and AeroVironment Inc., have been riding high as federal expenditures for munitions, drones and a missile-defense project bolster profits. The shutdown could temper enthusiasm for those stocks, all of which closed Monday at record highs, as well as for peers like Boeing Co. and Lockheed Martin Corp.
“We don’t expect much fundamental impact to defense firms, but sentiment may wane,” TD Cowen analyst Gautam Khanna told clients last week.
Seaport Global Securities raised its recommendation on shares of General Dynamics Corp. to buy from neutral this week, saying any pullback in the stock due to a shutdown would give investors an entry point.
Government Services, Airlines
Firms such as Booz Allen Hamilton Holding Corp., Leidos Holdings Inc. and CACI International Inc. that provide consulting and tech services to the government may not fare as well. Their revenue has taken a hit when the government has closed in the past, though the impact has tended to be small, according to Truist’s Tobey Sommer. Any protracted closure would likely hit profits.
Then there are airlines, which rely on government-funded travel for up to 2% of their annual revenue. A lengthy interruption to that sales stream would hit an industry already on the back foot. Worse, the thousands of federal employees who would be without regular paychecks may curtail leisure travel, according to Jefferies’ Sheila Kahyaoglu.
In the past, both groups of companies have sold off just before a shutdown and bounced back while it’s ongoing, Kahyaoglu wrote. The S&P 1500 Airlines Index fell 1.9% Tuesday, closing out its worst month since March, while CACI and other services contractors have faced volatility on worries about a broader push to cut government spending.
Cyclical Stocks
Here, a shutdown’s impact on the economy is key. If it lasts long enough to meaningfully slow growth and send unemployment higher, it will threaten sentiment in sectors like industrials and financials, said Matt Gertken, chief geopolitical strategist at BCA Research. Those industries are home to firms whose fortunes are closely linked to the US economy.
“If you had a long shutdown, it could simply call attention to the many risks that are on the radar,” Gertken said.
Industrial giants like Caterpillar Inc. and Deere & Co. have rallied from April lows, but the sector still faces tariffs and a slowdown in the manufacturing economy.
Shares of financial firms, from banks like JPMorgan Chase & Co. to asset managers like Apollo Global Management Inc., saw volatility earlier this year amid worries about the strength of the economy. Companies closely linked to the health of the consumer, such as fast-credit provider Affirm Holdings Inc., are prone to especially large swings.
Bloomberg Economics estimates that 640,000 federal workers will be furloughed during a shutdown, pushing the unemployment rate up to 4.7%. It will stay elevated even after the shutdown ends if Trump follows through on his threat to permanently dismiss some workers.
Investors worried that cyclicals will take a hit may rotate into defensive corners of the market like health care and utilities, Gertken added.
Brace for Volatility
The broader equity market has a habit of ignoring budget fights: The S&P 500 Index has barely moved on average across the last 20 shutdowns, according to data compiled by Truist. Wall Street pros are holding steady in their portfolios this time, too.
But a short-term bump in volatility becomes especially likely if data delays make the outlook for interest rates less clear, Jennifer Timmerman of the Wells Fargo Investment Institute said in a note. The Bureau of Labor Statistics would likely delay Friday’s payroll report, and a prolonged budget fight may imperil inflation data scheduled for Oct. 15.
Reports from private companies like the Institute for Supply Management — scheduled to release manufacturing and services data later this week — will take on new importance, according to RBC.
The S&P 500 shook off concerns on Tuesday, rising 0.4%. In the longer run, though, any hit to the economy threatens to take the wind out of a rally that is already showing signs of cooling.
“The market is struggling to find some momentum up here,” said Mark Malek, chief investment officer at Siebert Financial. “It’s hard to say that it’s a positive for this market.”
–With assistance from Carter Johnson, Felice Maranz, Matt Turner, Alice Gledhill and Farah Elbahrawy.
