What the shutdown may mean for the economy

The longest government shutdown in US history may weigh on sentiment.

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Key takeaways

  • Historically, the impact of shutdowns on markets has been fairly short-lived, though the current shutdown is the longest in US history.
  • Investors should focus on their strategies and not overreact to individual events in the markets.
 

The federal government remains shut down. Investors facing concerns about slower earnings and rising interest rates now have to consider the impacts of the longest government shutdown in United States history.

Several federal departments shut down on December 21, 2018, after Democrats and the President failed to reach a compromise on the $5 billion funding request for a wall along the US-Mexico border. Since then, little progress has been made to reach a deal, and a path forward to fund and reopen the government is unclear.

While the partial shutdown only affects about one quarter of the federal government, key departments, including the Department of Homeland Security and the Department of Treasury, are experiencing its impacts. As these effects become increasingly critical with each passing day, political pressure to resolve the impasse continues to mount, which could force a resolution to this stand-off.

As the shutdown continues, other fiscal deadlines are on the horizon. Congress will need to reinstate and raise the debt ceiling this year, as the current debt limit suspension expires on March 1. Treasury Secretary Steven Mnuchin has called on Congress to raise the debt ceiling to prevent the government from crossing the debt limit threshold in March. However, in the absence of Congressional action, Secretary Mnuchin would likely employ “extraordinary measures” to create additional borrowing capacity beyond the deadline, as the Department has done in the past.

Historically, debt ceiling negotiations present intense political challenges for members of Congress, especially with a divided Congress. Investors also tend to be more wary of debt ceiling debates than government shutdowns because of potential far-reaching economic consequences if the US defaults on its debt.

What it means for the economy

Dirk Hofschire, senior vice president on Fidelity's Asset Allocation Research Team, says that in terms of magnitude that can be measured, the government shutdown is a small drag on the economy but not a devastating blow that will create a recession by itself.

"We've had a number of shutdowns over the past 30 years, and most of these periods experienced a relatively limited and temporary impact on overall economic growth," says Hofschire. "However, this is now the longest running shutdown, and the longer it persists the greater the damage will be."

In addition to the direct impact of hundreds of thousands of workers not receiving paychecks, the uncertainty around an open-ended shutdown threatens to broaden into a bigger drag on business and consumer confidence. If businesses and consumers don't know when certain government services will be up and running, it becomes more difficult to make investment or spending plans.

Hofschire says that Fidelity's Asset Allocation Research Team still thinks the US is in the late-cycle phase of expansion. Even with the government shutdown, the near-term odds of a US recession remain low. Late-cycle periods have historically featured both ups and downs in the asset markets, being characterized by higher market volatility than the relative calm we've enjoyed in the markets over the past several years. The government shutdown is adding to uncertainty at a time when overall uncertainty is already high and markets have already become more volatile.

Read Viewpoints on Fidelity.com: Q1 market update: Facing uncertainty

What investors should consider

There are always political and event risks that have the potential to impact sentiment or even economic activities. But investors who have built a long-term plan generally don't need to worry about these short-term events: If you have an investment strategy built around your goals, financial situation, timeline, and risk tolerance, you likely don't need to make any changes when headlines like this pop up.

Investors who have moved from their long-term plan may want to rebalance to be closer to their target mix as the markets go through the uncertainty of the late phase of the business cycle.

More active investors may want to read the US stock outlook, to see how some of Fidelity's professional money managers are approaching this market.

Next steps to consider

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