US: Market implications of a shutdown - TDS

The research team at TDS explains that with the risk of a US government shutdown remaining elevated in the near-term, they see several implications for markets and lists down few of them.

Key Quotes

“Flight to quality: The 2013 government shutdown lasted for 16 days. Equity markets did not decline substantially ahead of the shutdown and actually rallied during the shutdown period. Fed pricing was nevertheless pushed out, with the market’s expectations for the first rate hike delayed by 6 months in the month prior to the passage of a CR. However, this may have been a function of the proximity of the shutdown to the taper tantrum, where markets had sharply pulled forward hike expectations. We expect the long end to bear the brunt of the yield decline in the event of a shutdown, as a government shutdown tends to have less impact on the economy and hence Fed policy.”

“Lower likelihood of tax reform: While the 2013 episode did not significantly dent risk assets, a government shutdown this time around could be more impactful. A shutdown would serve to remind markets of the level of contention on Capitol Hill and highlight the lack of unity within the Republican Party. We suspect that a government shutdown could prove more negative for risk assets than the 2013 episode suggests, with markets likely further lowering the odds of tax reform being completed in 2017. While we expect a positive economic backdrop and ongoing Fed rate hikes to keep yields buoyed, a delay in the timing or decrease in the scope of tax reform could push Treasury yields lower in the near-term.”