The Stakes of Another Government Shutdown

Our Deputy Head of Global Research Michael Zezas explains why the risk of a new U.S. government shutdown is worth investor attention, but not overreaction.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Deputy Head of Global Research for Morgan Stanley. 

Today, we’ll discuss the possibility of a U.S. government shutdown later this week, and what investors should – and should not – be worried about. 

It’s Wednesday, January 28th at 10:30 am in New York. 

In recent weeks investors have had to consider all manner of policy catalysts for the markets – including the impact to oil supply and emerging markets from military action in Venezuela, potential military action in Iran, and risks of fracturing of the U.S.-Europe relationship over Greenland. By comparison, a potential U.S. government shutdown may seem rather quaint. 

But, a good investor aggressively manages all risks, so let's break this down. 

Amidst funding negotiations in the Senate, Democrats are pressing for tighter rules and more oversight on how immigration enforcement is carried out given recent events. Republicans have signaled some openness to negotiations, but the calendar is really a constraint. With the House out of session until early next week any Senate changes this week could lead to a lapse in funding. So, a brief shutdown this weekend, followed by a short continuing resolution once the House returns, is a very plausible path – not because either side wants a shutdown, but because they haven’t fully coalesced around the strategy and time is short. 

Of course, once a shutdown happens, there’s a risk it could drag on. But in general our base case is that the economic impact would be manageable. Historically, shutdowns create meaningful hardship for affected workers and contractors. But the aggregate macro effects tend to be modest and reversible. Most spending is eventually made up, and disruptions to growth typically unwind quickly once funding is restored. A useful rule of thumb is that a full shutdown trims roughly one‑tenth of a percentage point from the annualized quarterly GDP for each week it lasts. With several appropriations bills already passed, what we’d face now is a partial shutdown, meaning that figure would be even smaller. 

For markets, that means the reaction should also be modest. Shutdowns tend not to reprice the fundamental path of earnings, inflation, or the Fed – which are still the dominant drivers of asset performance. So, the market’s inclination will likely be to look past the noise and focus on more substantive catalysts ahead. 

Finally, it’s worth unpacking the politics here, because they’re relevant. But not in the way investors might think. The shutdown risk is emerging