Prediction markets and duration risk

An extended U.S. government shutdown raises the risk for weaker growth potential. Our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas suggests key checkpoints that investors should keep in mind.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy.

Today: Three checkpoints we’re watching for as the U.S. government shutdown continues. 

It’s Wednesday, October 8th at 10:30am in New York. 

The federal government shutdown in the United States has crossed the one week mark. But if you’re watching the markets, you might be surprised at how calm everything seems. Stocks are steady. Bond yields haven’t moved much, and volatility’s low. 

It’s more or less the scenario my colleague Ariana and I had talked about in anticipation of the impasse in Washington. We’d noted the potential for uncertainty for investors and market reaction depending on how long the shutdown would last. 

So that raises a big question: what, if anything, about this government shutdown could shake investor confidence and start moving markets? 

The question is worth considering. Prediction markets now suggest the most likely outcome is that the government shutdown will not end for at least another week. And as we’ve seen in past shutdowns, the longer it drags on, the more likely it is to matter. That’s because risks to the economic outlook start to accumulate, and investors eventually have to start pricing in a weaker growth outlook. 

There’s a few checkpoints we’re watching for – for when investors might start feeling this way. 

First, the missed paycheck for furloughed federal workers. The first instance of this comes in a few days. Less pay naturally means less spending. Studies suggest that spending among affected workers can drop by two to four percent during a shutdown. That’s not huge for GDP at first; but it’s a sign the shutdown is having effects beyond Washington, DC. 

Second, this time might be different because of potential layoffs. The administration has hinted that agencies could move to permanently cut staff — something we haven’t seen before. Unions have already said they’d challenge that in court. But if those actions start, or even if legal uncertainty grows around them, it could raise the economic stakes. 

Third, we’re watching for real disruptions to economic activity resulting from the shutdown. The last shutdown ended when air traffic in New York was curtailed due to a shortage of air traffic controllers. We’re already seeing substantial air traffic delays across the country. More substantial delays or ground halts obviously impede economic activity related to travel. And if such actions don’t coincide with signals from DC of progress in negotiating a bill to reopen the government, investors’ concern could grow. 

So here’s the bottom line: markets may be right to stay calm — for now. But the longer this shutdown lasts, the more likely one of these pressure points pushes investors to rethink their optimism. 

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