The current US government shutdown has become the longest in history. One would think that a serious matter, such as Congress being unable to agree on how to fund the government, would negatively affect US assets. Yet US stocks have recently hit record highs. The dollar has been gaining strength as the shutdown continues. Why?
Financial markets haven’t been significantly affected by the government shutdown. After all, essential services continue to function, and businesses can continue to operate as usual. The primary concern is the lack of official data from the government, including inflation, GDP, and employment figures. Although over time, the lack of regular funding for the government can cause accumulating issues. Over a million federal workers are expected to continue going to work, but they won’t get paid until the political standoff in the Capitol is resolved. Staffing problems at the FAA are causing delays and flight cancellations, which are perhaps the most notable symptoms of this issue.
What About the Markets?
In the first quarter, markets were in “sell America” mode as economists worried that the trade war would slow the economy, push up prices, and the Fed would keep interest rates in restrictive territory. That caused the dollar to weaken at the fastest rate in years. However, the dour predictions of the US economy stagnating or falling into a recession have not materialized.
Although there are still worrying signs for the economy, the latest crop of data has generally been positive. Those include the Fed’s GDPNow, which predicts Q3 GDP to have risen at a 4.0% annual rate, up from 3.8% in the second quarter. Of course, with the government shutdown, we won’t get the official data for quite some time. Meanwhile, private payroll data came in stronger than expected, despite a hiring freeze in the Federal government. If the shutdown is causing a significant drag on the economy, it’s not yet reflected in the data.
Will the Fed Hold?
The dollar has also benefited from the Fed’s more hawkish stance. Before the last meeting, markets were pricing in a more than 80% chance of a rate cut in December. Then Fed Chair Jerome Powell suggested that a rate cut next month was not a done deal. The stronger jobs data, compounded with still high inflation indicators, have caused markets to pare back their expectations for a December cut to around 60%.
A net selling of dollar-denominated assets drove the weaker dollar at the start of the year as investors looked overseas for growth. Since September, however, those flows have reversed. Investors appear to think there is still more upside to US assets, notably after Q3 earnings so far this season have largely outperformed expectations. Hedge fund managers noted that net flows are now positive into the US, which could further prop up the dollar if the trend continues.
When Will the US Government Shutdown End?
The dollar may be outperforming due to factors other than the government shutdown. After all, the lack of official data, in particular, generates considerable uncertainty. Markets tend to underperform amid uncertainty. A resolution of the political impasse in Washington might give the markets a boost.
The problem is that politicians tend to respond more to public sentiment than to market indicators, which makes it difficult to predict when an agreement can be reached. So far, polling hasn’t shown a significant shift in opinion among American voters, which is likely the key factor that will decide which side eventually agrees to compromise on spending.
