MARKETS ASSESS THE IMPACT OF A GOVERNMENT SHUTDOWN
c.2013 New York Times News Service
As investors cautiously pulled back from the markets, economists were grappling with how much a government shutdown could dent confidence in an already fragile economy.
Stock markets around the world fell Monday, though the declines were relatively modest in the U.S., while negotiations in Congress remained stalled.
Many on Wall Street think the direct hit of a shutdown would be relatively minimal to the factors that drive stocks. An estimated two-thirds of the government — the so-called essential functions — will continue operating Tuesday.
But several economists have said the shutdown would most likely have a broader impact on market psychology if it lasted for more than a few days, and could drag down an economic recovery that has had trouble gaining traction.
“You have an economy that has already shown some hesitation,” said Diane Swonk, the chief economist at Mesirow Financial. “That’s the last thing we need right now.”
Wall Street, however, is more worried that the clash on the government shutdown could be a harbinger of fights over the government’s borrowing limit.
The Treasury Department has estimated that it will no longer be able to issue new bonds after Oct. 17 without authorization from Congress. Several Tea Party Republicans have said they will not agree to lift the so-called debt ceiling without the White House making several compromises — something the White House has said it will refuse to do. If there is no agreement, the government would be forced to immediately operate on a balanced budget and could default on its debt — something that has never happened before.
“Before this week, I would have said to you that the odds of a government shutdown would be pretty small,” said Charles Comiskey, the head of Treasury bond trading at the Bank of Nova Scotia in New York. “What we are learning from this broken Congress we have is that anything is possible.”
Wall Street was still betting Monday that a compromise would be reached before then. However, the continuing gulf between Democrats and Republicans over the shutdown brought a default into the realm of the possible, prompting several strategists to issue reports presenting dire consequences if no deal is reached on a debt ceiling.
“I’ve got no basis for guessing what would happen there because it would be unprecedented,” said Russ Koesterich, the chief investment strategist for BlackRock.
Large swaths of U.S. business have come together behind the idea that the shutdown is a mistake that could have immediate economic repercussions. Over 250 industry groups signed onto a letter on Monday calling for a quick resolution to the stalemate, departing from the more mixed prescriptions business groups have given during past budget battles.
“It is not in the best interest of the employers, employees or the American people to risk a government shutdown that will be economically disruptive and create even more uncertainties for the U.S. economy,” said the letter, which was put together by the U.S. Chamber of Commerce.
President Barack Obama is scheduled to meet Wednesday with members of the Financial Services Forum, which includes the chiefs of banks like JPMorgan Chase and Goldman Sachs, who are in Washington for an annual meeting. The group is expected to discuss a range of financial issues including the debt ceiling, a person briefed on the talks said.
Investors are keeping a close eye on the market for U.S. Treasury bonds, one of the most heavily traded markets in the world, and a benchmark for the rest of the financial system.
If the government did stop paying interest on its outstanding bonds, those bonds would most likely become less attractive. But investors responded in unexpected ways the last time the government approached the debt ceiling in 2011. Back then, investors flocked to Treasury bonds as a safe haven, despite the fact that the turmoil was caused by concern about the future of those same bonds.
This time around, the dynamics of the market are even more complicated because bond prices have recently been driven by bets on whether the Federal Reserve will ease off the bond-buying programs it has used to stimulate the economy. Some bond traders are betting that political strife will make it more likely that the central bank will continue buying Treasury bonds, making them more attractive.
On Monday, the movements in the bond market showed the complicated and sometimes contradictory forces at work. Even while stocks generally dropped, the prices of Treasurys were volatile.
The yield on the benchmark 10-year note fell to 2.62 percent, from 2.63 percent Friday, and the price increased 3/32 to 99.
“It’s a little bit of a tug of war,” said Kevin Giddis, the head of bond trading at Morgan Keegan.
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Though stocks had a down day, the direction was clearer. The Standard & Poor’s 500 stock index dropped 0.6 percent, or 10.20 points, to 1,681.55. The Dow Jones industrial average ended down 0.84 percent, or 128.57 points, to 15,129.67. The Nasdaq was off 0.27 percent, or 10.12 points, to 3,771.48.
The overhang of the shutdown provided a bad ending to what had been a good quarter, as the broader markets fell in seven of the last eight trading days. For the third quarter, the S&P rose 4.7 percent and the Nasdaq soared nearly 11 percent, and the Dow was up 1.48 percent.
In Asia and Europe, leading indexes fell even more sharply Monday. European stocks were under additional pressure because a growing political crisis in Italy is threatening the government there.
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The fears about a government shutdown were overshadowing a few recent indicators that the economy may have been strengthening. Manufacturing activity in the Chicago area picked up more than expected in September, according to a private index released Monday — the latest promising economic data.
Ian Shepherdson, the chief economist at Pantheon Macroeconomics, said that a shutdown would not hit just the government employees sent home — it would also cause trouble for contractors and for the businesses where government employees spend money. He estimated that a shutdown could slow economic growth in the fourth quarter by 0.07 percent for each day it goes on.
“Investors who have been relaxed about this are going to get a very significant wake-up call if they’re not careful,” Shepherdson said.
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Some of the complacency on Wall Street has come from the history of market movements during past shutdowns. The precedent is not all that frightening, according to data put together by Joseph P. Quinlan, chief market strategist at U.S. Trust, Bank of America Private Wealth Management. When the government closed for 21 days in late 1995, for instance, the S&P 500 actually rose 0.1 percent during the shutdown.
But Quinlan was quick to point out that this time around was somewhat different because any shutdown would be immediately followed by debate over lifting the debt ceiling. While there is precedent for the government closing down, there is none for a default.