• US. government was shutdown for three days starting on Saturday, 19 January 2018
• A temporary spending bill was signed by President Donald Trump on Monday evening.
• The temporary bill will fund the government through 8 February 2018.
• Watch out for a longer-term budget bill to materialised before the U.S. Treasury exhausts their extraordinary measure in March 2018

What happened

U.S federal government shut down for the 19^th time since 1976. This was hardly a novelty for the markets as reaction on Monday’s trading activity were muted if anything. The shutdown was due to the “spending gap” as the government funding was deemed insufficient for the full operation of the Federal Government. This results in hundreds of thousands of federal employee being on furlough on Monday.

The last government shutdown occurred in September 2013 under President Obama, resulting in a 16 days shutdown.  These shutdown are generally due to the dispute over the use of funds between the Democratic and Republican party. 

Fig 1: Length of Government shutdown since 1976

Source: US Federal Government, PSR

How did the market react

The recent shutdown was too short for us to have any meaningful analysis of the full market reaction as 2 out of the 3 days of shutdown were on the weekend. Technically, the shutdown only affected the federal government operation on Monday before President Trump’s sign the temporary bill to extend the spending till 8 Feb 2018 that same evening. However, we can take cue on the previous shutdown periods to grasp a better understanding of the market reaction if the government was to shut down again on the 8 February 2018.

Fig 2: Previous Shutdown have modest effect on Financial Markets

Source: Bloomberg, PSR

Equity markets: From the graphs above, we can safely conclude that a government shutdown has modest impact on the financial market. Equity market fell no more than 2% in the first ten days after the government shut down. The Nov 1995 case saw equity market rallying during the closure.

Bond yields/currency: There was no volatile spike in Treasuries yield as one would typically expect from a government that is on the verge of default. In fact, Treasuries yield slide back to its downward trajectory even before the government resume operations. The immediate impact was observed in the Dollar Index (DXY) as the DXY decline immediate in all three cases ending lower in two cases before the government reopened.

If we were to extend our observation to 40 days after the shutdown, we note that in all previous three cases, equity market ended positively and the dollar strengthened as well. Treasuries yield headed lower except in the 2013 case when yield remain higher after the shutdown.

The recommencement of government operation was almost always due to a bi-partisan resolution of the budget spending after which a longer-term bill can be passed. Therefore it will be imperative for one to understand the pivotal point for the current budget negotiation. A failure to conclude on the budget bill can lead to a potential U.S. default as the U.S Treasuries not only run out of funds to operate, but they will also fail to fulfil their debt obligations.

Undocumented Immigrant child in exchange for $25 billion on border security

The two biggest issues delaying the current budget negotiation is on the Deferred Action for Childhood Arrivals (DACA) and defence spending. The Democrats demand that the relief for DACA be tied to any longer-term budget. At the other end, the defence hawks from the Republicans want a larger budget on defence spending.

Both parties are eager for a long-term budget agreement, and any legislation to boost spending by upwards of $250 billion over two years would likely need broad bipartisan backing in both chambers, the Senate as well as the House of Representatives. Although Senate Democrats were willing to give in and not include the DACA in the negotiations, the House Democrats have voiced their disapproval of any deal without a firm commitment to the DACA relief.

On 26 Jan 2018, President Trump threw a lifeline by offering a “legislative framework” for Congress to rely on as an outline for a draft bill. In the framework, Trump was willing to support a path to citizenship for as many as 1.8 million undocumented immigrant children. In exchange, Trumps wants Congress to provide $25 billion for the southern border wall and enhanced security at ports of entry.

Ultimately, a bipartisan budget deal has to be made and signed into law by President Trump to avoid a prolonged government shutdown after 8 Feb 2018. 

Economy still buoy base on our Recession Indicators

Based on our recession indicators, we are still positive about the US economy and the financial markets.