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2017-08-26 23:36:03
Fair Game: Shut Down the Government, and This Time, Investors Will Care

“If we have to close down our government, we’re building that wall.”

So proclaimed President Trump at a rally in Arizona on Tuesday, raising the specter of a federal government shutdown if Congress fails to provide the money to put up a wall between Mexico and the United States.

And with those words, the president managed to rattle investors in two big financial markets — United States Treasuries and stocks.

In recent years, government shutdowns have become so common that markets have either embraced them or shrugged them off. But as investors absorb the possibility of a closure this fall, market tremors are likely to intensify, experts say. The past will not necessarily be prologue this time around.

That’s the view of Isaac Boltansky, director of policy research at Compass Point Research & Trading in Washington. Noting that during the past three shutdowns, the stock market was unfazed by the political gamesmanship, Mr. Boltansky said, “I think this time will be worse because of the uncertainty from President Trump.”

Investors are grappling with two matters right now: the need to raise the nation’s debt ceiling in September so the government can pay its obligations, and the desire to have a federal budget in place by Oct. 1 to avoid a shutdown.

Earlier this week, Treasury Secretary Steven Mnuchin tried to reassure investors on the first matter. “We’re going to get the debt ceiling passed,” Mr. Mnuchin vowed at an event in Louisville, Ky., on Monday. He also predicted that the ceiling would be raised cleanly — that is, without spending reforms attached to the increase that are intended to move the government toward a balanced budget.

But the next day Mr. Trump invoked the government shutdown, spooking Treasury investors. Faced with the possibility of problems with both the debt ceiling and a shutdown, investors holding T-bills maturing in early October began selling. Short-term Treasury investors, like the institutions that oversee money market funds, can’t afford to wait around to see if they’ll be paid on time. It’s easier to bail out of the holdings that could be affected.

Stocks also weakened on the prospect of a shutdown — a very different investor response than has been seen during recent government closures.

Mr. Boltansky looked back at the stock market’s performance during all 18 government shutdowns, starting in 1976. He found that the Standard & Poor’s 500-stock index averaged just a 0.6 percent loss over the course of those closures.

Early on in shutdown history, investors reacted very negatively. Closures in 1976 and 1977 coincided with 3 percent declines in the S. & P. 500.

As investors grew more accustomed to shutdowns, they seemed to become more blasé about them. During the mid-1990s and the 2013 closure, for instance, stocks actually rose. They gained 3.1 percent during the 2013 stoppage.

Although stocks rose on Friday, investors should not expect such a performance this time, Mr. Boltansky said. One reason is that a government closure would raise serious doubts about the ability of the Republicans in Congress to get anything done.

“It will confirm one of the market’s fears that the Republicans are not a political party but a government coalition made up of leadership loyalists, conservatives and moderates,” Mr. Boltansky said. “If you have that dynamic, how can you get anything done legislatively?”

Remember that investors have been propelling stocks to record highs in part because of their expectations for pro-business action in Washington. A government shutdown could douse those hopes and drag down shares.

Even Mr. Trump’s deregulatory agenda, which he has been pursuing administratively rather than legislatively, could be harmed by a government closure, Mr. Boltansky said. For example, it would stall confirmations of Mr. Trump’s regulatory nominees — including Joseph Otting, who was nominated as comptroller of the currency, and Randy Quarles, chosen to run bank supervision at the Federal Reserve Board. Both nominees are expected to loosen the rules for financial companies when they are in place.

Plans among Republicans for broad-based tax reform may also be hurt by a government shutdown. Investors looking for big increases in corporate earnings as a result of lower tax rates may be in for a disappointment.

Here’s another question: How can the Federal Reserve Board begin to normalize monetary policy, as it has said it would, amid a government closure?

Then there’s the real disruption that government closures bring. Federal employees are furloughed, national parks closed and loans to small businesses halted. These shutdowns can result in real downturns in economic activity.

Consider a report from the Office of Management and Budget detailing the effects of the 2013 government closure, which lasted 16 days. Citing estimates from the Council of Economic Advisers, the report said the shutdown might have reduced gross domestic product growth by 0.25 percent in the fourth quarter of that year.

The report’s list of negative effects from the shutdown is long. It said the stoppage delayed Food and Drug Administration approvals of medical devices and drugs, stalled almost $4 billion in refunds to taxpayers, halted or curtailed services for veterans, and cost the National Park Service $500 million. Some 700 small businesses that had applied for roughly $140 million in loans during the shutdown had to wait until it ended to gain approval.

In short, the ripple effects resulting from a government shutdown are likely to be significant. Investors who have grown used to stock prices that only go up might want to strap themselves in for a bumpy ride.