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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