Shutdown showdown: Economic and market impacts explained
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Sam Azzarello: Welcome everyone. Today we're hosting a quick 20-minute update call on the U.S. government shutdown. My name is Sam Azzarello and I lead content strategy within research, and I'm thrilled to be joined by three colleagues. We have Jay Barry, our global head of Rate Strategy, Michael Feroli, our Chief U.S. Economist. And joining us today is Eben Peck, who's part of our federal government relations team. Eben is based in D.C., and he has a wealth of expertise and knowledge across U.S. senate policy, political action, trade management. And he was saying earlier that this is one of his favorite topics. So let's talk. Eben, level set for us, rhetoric around what the Democrats are looking for, what the Republicans are looking for. Where are we at right now?
Eben Peck: Well, I was joking that this is my favorite topic, but I'm happy to be here today. So level set, Democrats want healthcare concessions to go along with any continuing resolution or CR, which is a measure to fund the government, extend government funding. These healthcare policy priorities have been somewhat vague, but the ones that they talk about the most are an extension of the Affordable Care Act or Obamacare premium tax credits that expire at the end of the year, reversal of Medicaid cuts in the Reconciliation Bill or One Big Beautiful Bill Act. I've heard reversal of cuts to the NIH and I've heard non-healthcare items like restrictions on the administration's ability to impound or not spend money that Congress has appropriated. Republicans simply want to extend government funding for seven weeks through November 21st to give the appropriations committee's time to write full year spending bills.
Sam Azzarello: Okay. So any status then on the negotiations between the parties? And I know it's hard to say, but how long do you think this plays out for? If you want to provide some context around 2018, 2019, that might be useful for clients and partners.
Eben Peck: Sure. The length is the million-dollar question, the one that I get the most. So, let me take the negotiations first. As we sit here, there are no negotiations going on. We saw there was a White House meeting on Monday with the congressional leadership of both parties, largely served to restate each side's positions in this debate. I read this morning that Senate majority leader Thune and minority leader Schumer, planned to meet on Friday, which is somewhat encouraging. The only thing I'll point to right now in terms of negotiations, and this is not formal, is during the vote in the Senate yesterday, which was the third failed vote on the Republican version of the CR, there was a bipartisan group of senators in intense conversations. You can see it on the camera, you can't see what they're talking about. So clearly there's an appetite to try to find a way out of this, because the last major shutdown was in 2018, 2019, that would, it lasted 35 days, although a lot of that fell over the holidays. So I think the impact was, was muted. So there's two theories here as to how long this lasts. One is that, Schumer needs to show his base that he's willing to fight, quote, unquote, and he doesn't have a ton of leverage right now. He won't have a ton of leverage in a week or two weeks, and that they find a way to get out of it. The other theory is that the, the well is so poisoned right now and getting more poisoned. The administration's being very aggressive in terms of additional clawbacks to money going to blue states and additional layoffs of federal employees, that this, we could be in for a protracted shutdown.
Sam Azzarello: I want to ask you two more questions before we go to Jay and Mike. The optics of this, right? So you mentioned Schumer back in March, he did this once, right, a continuing resolution, and the optics were not doing enough. Fast forwarding now, I've seen conflicting poll data as to who would proceed to be blamed for a government shutdown. Do you have any view from a data perspective around what party might take blame for this, this government shutdown?
Eben Peck: Yeah, I mean, the numbers are all, all over the map when you look at polling. I, I think there's a huge difference between a shutdown that lasts a week and a shutdown that lasts six, eight weeks or, or, or longer. The longer this goes on, the more painful it's going to be for everyone. Not just J.P. Morgan clients, but anybody who wants to travel, anyone who needs to call, you know, about their social security account, et cetera. And then I've, I've read a lot of articles about how shutdowns historically have played in the, in the next election. And, and I think the, the bottom line is probably not a ton. I mean, it feels like politically, uh, the camps are pretty set right now. So I, I don't see it having, having a massive impact, but we're just going to have to see. It would have more of an impact, I think, in internal party politics. So Schumer is concerned about his political base. Probably a lot of, a lot of other democratic politicians are as well. So we'll just have to see it. But it really depends on how long it lasts.
Sam Azzarello: Last question for you. If we got into the nitty-gritty logistics and what exactly shuts down in a shutdown, number of workers being impacted, specific sectors, functions you would flag?
Eben Peck: Remember, any programs that's supported by mandatory spending, tax revenue, et cetera, think Medicare, social security, Highway Trust Fund, et cetera, they're exempt from government shutdowns, continue to operate. That leaves about 27% of the budget, which is called discretionary. And in terms of those programs and, and employees, the White House has great discretion on who's essential and has to keep working with, although without pay and who gets furloughed, has to go home and has to stop working. So the latest numbers we saw of that population, about 750,000 federal employees are being furloughed, uh, as we speak. That's about one-third of the total for those discretionary employees, which is lower than the last shutdown, which was 40%. So it goes to show that the White House does have flexibility here. And, and the, the proportion of employees range from 89% furloughed at the EPA to 2% furloughed at Department of Treasury.
Sam Azzarello: Okay, fantastic. Thank you. Mike, expand on any potential economic implications of the shutdown.
Michael Feroli: Right. So historically, we haven't seen much impact of shutdowns on the data. And we do have almost two dozen shutdowns to look at to observe and see that it doesn't have much impact. Probably due to what Eben was saying, is that it affects a small part of the government. And historically, that third or 40% of federal employees who are furloughed get back pay. So they may keep spending. And so, you know, they still have their jobs. So for that reason, as I said, historically, we just don't see much impact. Now it could be worse this time because of the threatened layoffs, and then you're going to have, you know, actual job loss, and then you have to think about that in the context of reduced labor income, reduced consumer spending. So that is a risk. And I suppose the most immediate impact of the shutdown on, thinking about the economy is that we're not getting data. And so tomorrow we won't get the job report. And for as long as this goes on, we'll be operating a little bit blind. Of course, we're going to have things like yesterday, the ADP, we'll have various private data sources, but the real, you know, the meat of the data, which is the jobs report, and then CPI, retail sales, we won't get those. And so we are going to be operating a little bit blind, which could affect the Federal Reserve a little bit. We still think that in this environment it probably makes sense to cut again in late October as if then signaling, and it would be weird for them to go off of that, now that you have less data than they could.
Sam Azzarello: Okay. So a little bit more of an educational, but I think it's relevant for some of our international clients or maybe those less plugged into government dynamics. Can we go through what the key differences are between a government shutdown and a debt ceiling crisis? Because at times these have collided. This, that's not this case. So why is it important between the two?
Michael Feroli: So shutdown, first of all, we've had, as I said, almost, I think 20 shutdowns. So it's something we've gone through and we know what it does. We've never, in 200 and almost 50 years defaulted on the U.S. treasuries, treasury market. (laughs) So, and we would think that, you know, our past analysis has suggested that a debt ceiling, if we actually came to the point where the U.S. would have to default on its obligations could be rather catastrophic for financial markets. Jay might have some more to opine on that. I think he's probably done some work on that as well.
Sam Azzarello: Jay, would you like to add anything there? And then we'll come to your markets.
Jay Barry: I think Mike has had a very, you know, good lead in there that, there have been instances where we've had the debt ceiling debate conflated with the government shutdown. And in fact, that was the case in 2013, which was a pretty market moving event at the time. But as Mike said, because the debt ceiling was raised by $5 trillion when the One Big Beautiful Bill Act was passed back in July, it's taken that off the table. So from, you know, the perspective of what it means from a market moving perspective, like, I think that the data has been, has been taken down quite a bit. And maybe just to lead in a little bit further from there, Sam, it's what we have seen on average over the kind of four shutdowns we've seen over the last 30 years, which was two short shutdowns in late 1995, early '96, the October '13 shutdown, and the lengthy 1819 shutdown. There has been a tendency for the, for treasury yields to decline during the period. But what I would argue is, if you look at it in the 1995, '96 episode, the Fed was actually in the midst of a mini easing cycle and lowering rates, and that could have been the bigger approximate driver. In 2013, the Fed was actually considering tapering its asset purchase, slowing the pace of easing. But the conflagration or the, the combination of that and the debt ceiling debate and the risk aversion associated with it was a strong reason behind the rally. And then in 2018, '19, we had a pretty sharp shift in monetary policy where the Fed actually raised rates at the December of 2018 policy meeting, but then by January we were walking those back and actually talking about, you know, changing the way they look at inflation and inflation expectations and the context of not meeting target would ease later that year. So while the reaction's been consistent, it's been, I think, for different reasons than the shutdown itself and this time around with no debt ceiling debate, I tend to think that the impact on the markets is going to be much more limited. And then importantly, because this is not related to the debt ceiling as Mike intimated, and as Eben also said, there's no impact on the Treasury Department's functioning here. So the Treasury will continue to issue debt as it normally does, although, because there's something like 15% of the outlays that don't go out, it does mean that the Treasury's financing needs will be somewhat reduced. So we could see that through the channel, a slightly reduced T-bill issuance as the shutdown continues here.
Sam Azzarello: Jay, then I'll ask one corollary question because you spoke to historical instances what happened, what might happen in the short term, or, you know, you spoke about it again in the Treasury market, really. Prolonged shutdown, what could that mean? What would that look like?
Jay Barry: So maybe the first place I'll go there, Sam, and to lead with what Mike said is very locally and more medium term, the most important data point in the Treasury market every month is the monthly employment report. So, I'm being a little flippant here and saying it, but a lot of us don't know what to do tomorrow if we don't have an employment report, because it's going to leave us somewhat rudderless in the markets. And we say that because I think if you look at it in the Treasury market, over the arc of the last 20 to 30 years, we have on average delivered, you know, more volatility on payroll days than any other event of the month. And in fact, that's the way, the way that the, the, the rates imply volatility market actually sort of prices this as well. So it's going to be challenging to kind of discern what it means for the direction of Fed policy. I think fortunately for now, with the guidance that Chair Powell had given us at the September meeting, it made the likelihood of an October cut as it's in Mike's forecast, very, very likely. But if the shutdown is lengthier, it could muddy the waters about how markets price, the likelihood of any cuts past December. And of course, we've had some private employment data in the form of ADP yesterday, which gave people a sense that labor markets are, are loosening further, but it may complicate the picture over Fed policy and how the markets price, the ongoing Fed easing cycle here. But then beyond that, there are implications for other asset classes as well. And in, in fact, importantly the tips market. So if we get to the point where a shutdown does persist here, and I'm looking at online markets right now, the highest probability seems to be the shutdown lasting anywhere between 10 and 30 or 35 days, then we may not get a September CPI report released by the BLS. And that matters because the universe of inflation linked product in the U.S., both the tips market and the inflation swaps market is linked to U.S. CPI. So fortunately there is a fallback provision for the inflation linked market, but it would result in pricing that is distinctly different than where we are right now. So if there's no CPI report released for the month of September for tips, it would fall back to the extrapolation of the 12-month trend in CPI, which would result in a CPI index for benchmarking and tips purposes. That's about a quarter point lower than where it's right now. So markets are, have declined, I think, in reaction to the shutdown occurring, but understanding that it probably takes a very lengthy shutdown to actually not have this impact pricing in the inflation market. It's had a real limited impact right there, but it's certainly been part of a discussion and made it more challenging to trade the inflation markets very locally with this uncertainty.
Sam Azzarello: Jay, thank you. Mike, one last question for you, and then I think we'll start to wrap. I know it's hard to say, but in a world where we have a protracted government shutdown, is the impact to the economy solely through the channel of the government not spending, or is there a sentiment piece that could be possible adding to uncertainty? What's the view?
Michael Feroli: Maybe three things I'd say. One is, just very prosaically, each week we have a government shutdown subtracts about one-tenth of a percent from annualized GDP growth via reduced government activity. There could be a sentiment channel. You know, if we get into uncharted territories, everything is up for grabs, right? And, and, uh, we have seen modest sentiment effects in prior shutdowns. If we go past, you know, a few weeks, then, uh, it's harder to say with confidence that sentiment will be just sort of a minor side chill. And then I guess third, and building off a little bit of what, what Jay was talking about is that, the longer we're in this data void, the more destructive it could become, right? So if we go past long enough that we can actually collect the data for the employment report, we've never had a missing employment report. And so, I think it's interesting that a few weeks ago with all the news about BLS, we were kind of hypothetically saying how important it is to have official government data. And I think this could be a quick test of how important it is in terms of the private sector's ability to form a complete picture of the economy.
Sam Azzarello: Thank you. Okay. Before we close, Eben, I'd like to ask you one quick question without putting you on the spot. So Mike alluded to it, there has been reports that budget director, Russell Vought, has ideas and plans to maybe lay off federal workers, use this as an opportunity to reduce and cut the federal workforce. Any insight on how that might be playing into the negotiations and what the Democrats are saying or not saying?
Eben Peck: It certainly raises the stakes. I mean, I'll point out that the administration's been very aggressive with laying federal employees off already. The last number I saw was about 300,000 laid off already. So, one way to think about it is if there's agencies that the administration wants to empty out, they've largely done that already, I think USAID, Department of Education. But that said, this is a real threat. Like, some of this crisis seems kind of improvised, but I think there is a plan to use, not let a crisis go to waste, and continue to downsize federal workers. I'll just point out that there, there's been a lot of downsizing already. What they're talking about is that RIF process, reduction in force, that it's an orderly process. People get notice, they can appeal, uh, sometimes in fact, in some cases they've had to walk that back. So it's not like this will happen overnight.
Sam Azzarello: I want to thank Eben, Jay and Mike for their time and insights, and I want thank all of you for joining.
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