Prolonged US government shutdown could raise market risks

NEW YORK, Oct 2 (Reuters): Investors have anticipated for weeks the risks of a US government shutdown, opens new tab to markets. Now that it is here, they are hoping it will be brief.
A shutdown that lasts at least several weeks could cause confusion about the Federal Reserve's monetary policy path as the central bank will be without government data that helps guide its decisions, while also posing a possible drag on economic growth the longer it extends.
"We have the markets trading at extended valuations at all-time highs with an economy that seems to be showing some pretty clear signs of slowing," said Eric Kuby, chief investment officer at North Star Investment Management.
"That slowness in the economy is going to be exacerbated by the lack of government spending, and the longer it goes on, the more difficult it is to overcome those challenges."
The shutdown, impacting a wide swath of government operations, is leading to the furlough of federal workers, while US President Donald Trump, whose campaign to reshape the government is on track to push out some 300,000 workers by December, has warned congressional Democrats that a shutdown could lead to more job cuts.
Shutdowns in the past have typically had limited impact on the markets, with the S&P 500 stock index roughly flat on average during shutdowns since 1976, according to LPL Financial. More recently, since 1995, the S&P 500 finished higher during every shutdown, according to John Luke Tyner, portfolio manager at Aptus Capital Advisors.
However, this impasse could present a different risk, some investors say. The shutdown comes alongside concerns about America's fiscal health - highlighted by a downgrade earlier this year of the country's sovereign debt - and as companies absorb the impact of tariffs.
"It's the cumulative, compounding effect of all of these events - the US credit rating downgrade, the changes to the trade regime and now the shutdown - that worry me," said Brian Shipley, chief investment officer of Coldstream Wealth Management.
Shipley said if it extends past the two-to-four week time frame seen in the past, it opens up a question about how investors globally will view the US He said he has shifted some assets out of Treasury bills to a portfolio manager with a wide mandate to own assets including international bonds.
The shutdown's hit to growth will depend on its length, analysts said.
Oxford Economics estimated that a partial government shutdown reduces economic growth by between 0.1 and 0.2 percentage points per week.
A shutdown that lasts the entire quarter would reduce fourth-quarter real gross domestic product by 1.2 to 2.4 percentage points, Oxford Economics said in a note, while cautioning that a shutdown of that length has never occurred before.
A long-lasting shutdown may weigh more on consumer sentiment, said Lauren Goodwin, economist and chief market strategist at New York Life Investments.
The 2018-2019 shutdown that lasted over 30 days coincided with a 7 per cenr hit to confidence in the University of Michigan consumer survey, Goodwin said in written commentary.
The 19 partial or full government shutdowns over the past 50 years have gone on for an average of about eight days, according to analysts at Canaccord Genuity.
Analysts at BBH said in a note that a shutdown of more than two weeks "increases the downside risk to growth."
That in turn, BBH said, raises the likelihood of a more accommodative Fed which can further weigh on the US dollar.
Indeed, many investors were focused on how the shutdown might sway Fed policy with the central bank due to meet at the end of the month and the likelihood now of delays to key data, starting with the US employment report that had been scheduled to be released on Friday.
That expected gap in government releases could place more emphasis on alternative data including the ADP National Employment report published on Wednesday, which showed private payrolls dropped by the most in 2-1/2 years in September.
"If the shutdown drags on, the weakness in the ADP will be all the Fed has to go on," Capital Economics analysts said in a note.
Peter Cardillo, chief market economist at Spartan Capital Securities, doubted the shutdown would last two or three weeks, "but if it should, that puts the Federal Reserve in a big bind."