The economic impact of the partial government shutdown will depend on how long it lasts. Government workers will still get paid, but those supporting government workers (food service, etc.) will not. Economic data reports and Treasury auctions may be delayed. For financial market participants, it’s a sense of “been there, done that.” We’ve been through shutdowns before and we know that the government will reopen at some point. We shouldn’t expect significant market disruptions. However, stock market participants should keep an eye on the bond market, where the 10-year Treasury note yield has approached (if not breeched) a critical level.
The broad consensus among economists is that growth should be moderately strong in the near term, but limited by the further tightening in labor market conditions. Near-term risks to the outlook are weighted mostly to the upside (stronger wage growth, stronger business investment, stronger global growth), but there are some downside risks as well (higher interest rates, trade war, geopolitical shock). The long-term trend in GDP growth is seen as a little less than 2% per year (labor force growth of 0.5-0.6% plus productivity growth of around 1.1-1.3%). We may see GDP growth above that trend in the near term if the unemployment rate continues to fall. However, a sharper decline in the unemployment rate would trigger a faster tightening of monetary policy. Indeed, the financial markets have begun pricing in a more aggressive Fed in 2018.
One of the main issues with the government shutdown is the loss of confidence in the system. Setting a budget is the bare minimum requirement. All else equal, that loss of confidence implies that Treasury yields ought to be higher than they would be otherwise. The Federal Open Market Committee is widely expected to be more hawkish this year, which is also putting some upward pressure on bond yields.
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The price of a stock can be thought of as a risk-adjusted discounted stream of future earnings. Hence, all else equal, higher interest rates mean a greater discounting of future earnings and lower share prices. In turn, a drop in share prices should lead to increased capital flows into the bond market, lowering yields. Large moves in the bond market will have consequences for the stock market and vice versa. The dynamics here are hard to forecast, but we’re likely to see some increase in market volatility.
Over the last month, there has been increasing concern about the slope of the yield curve, which is the single best predictor of the business cycle. An inverted curve nearly always precedes a recession. However, it depends on why the curve inverts. Typically, that’s because of increased expectations of a recession. Consumers become a little more cautious with their spending and businesses are less likely to make capital expenditures. We are a long way from that now. The yield curve is still nowhere near inverting, but it bears watching. While the near-term risks to the growth outlook are weighted to the upside, the risks for 2019 and beyond are to the downside.
I gave many economic presentations during the financial crisis. It was nothing but bad news, so to lighten the load I ended with a picture of a puppy. It was a cheesy bit, but always got a laugh and people went away feeling a little better. We welcomed Sam, a Decker rat terrier, into our household, as a companion for our deaf dog, Spartacus – and the result was that we had one dog who could not hear and one dog that would not listen. Sadly, the pest control people left the gate open last week and the dogs got out. Sam was hit by a car and died. A runner, he went out doing what he loved, and the end was mercifully quick, but as you know, losing a pet is hard. I’d like to think that Sam brought something positive during the financial crisis. He will be missed dearly.
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All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.
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