How Does A US Government Shutdown Affect The USD?

The U.S. government shutdown of 2018/19 will be historically viewed as a hotly contested standoff between competing political ideologies. Issues such as government spending, immigration reform and national security promoted a deep divide between President Donald Trump and Congressional leadership. A lack of bipartisan cooperation forced the stoppage of many non-essential functions of the federal government, bringing uncertainty and volatility to the U.S. dollar (USD).

U.S. Government Shutdowns: Definition And Historical Background

The U.S. federal government serves the public through an extensive collection of bureaus. Each calendar year, funding must be secured to ensure the seamless operation of these bodies. In the case of a full or partial government shutdown, select agencies are closed due to lack of funds.

At first glance, a federal work stoppage appears somewhat rare and chaotic. However, the history of government shutdowns in the modern era is extensive. The party in control of the White House or Congress is largely irrelevant, with political conflict being the only constant factor determining a government closure. Here is a list of U.S. federal government shutdowns since 1975, longest to shortest:^[1]

*At press time, the U.S. federal government shutdown beginning December 21, 2018 is the longest since in the modern era, from 1976.

As evidenced above, each instance of a government shutdown is unique and the result of a number of factors. Regardless, at the root of any government shutdown is the inability of Congress and the president to sign into law 12 appropriation bills funding federal agencies.^[2]

In the event a budgetary riff appears imminent, members of Congress can request an extension for the temporary funding needed to keep the government operational. Upon the president signing off on the request, known as a "stopgap measure," agencies impacted by the shutdown remain open for business. This procedure is not uncommon, with the latest example occurring in January 2018 when President Trump and Congress agreed to a stopgap and ended a three-day shutdown.^[3]

Economic Impact Of The 2018/19 U.S. Federal Government Shutdown

The U.S. government shutdown of 2018/19 came to pass because of a budgetary disagreement between President Trump and the newly split Congress. Due to victories in the 2018 Congressional Midterm Elections, the U.S. House of Representatives (HOR) fell under the jurisdiction of a Democratic majority. As a result, a late-2018 standoff over 2019's federal budget ensued.

While three quarters of the government had already been allocated funding by the 21 December 2018 deadline, the remaining portion remained unfunded. At the core of the disagreement was a US$5.7 billion allotment earmarked for national security, specifically for the construction of a physical barrier at the U.S.-Mexico border.^[4]

The lack of cooperation between the president and Congress created a budgetary stalemate. Individual bureaus such as the Transportation Security Administration (TSA), the Internal Revenue Service (IRS) and Securities and Exchange Commission (SEC) were directly affected. A total of nine departments were impacted, with a significant number of employees being furloughed or ordered to work without pay until the government reopened:^[5]

By late January 2019, the shutdown became the longest of its kind and affected more than 800,000 federal workers. While representing only a minute fraction of the more than 160 million participants of American workforce, the aggregate economic impact of the stoppage was not completely insignificant. Chairman of the Council of Economic Advisers Kevin Hassett reinforced the importance of the shutdown publicly. Citing internal data, he stated that for every week the federal government remained closed for business, quarterly U.S. economic growth fell by 0.13%.

The U.S. equities markets have historically exhibited a sensitivity to government shutdowns. Conventional wisdom states that "markets hate uncertainty." This notion is certainly applicable to a federal closure, as a broad spectrum of questions surrounding economics and politics may influence investor sentiment. However, the picture is not entirely negative. For instance, the Standard & Poor's 500 (S&P 500) stock index has actually climbed during 12 of 21 shutdowns (ending 2018) since 1975. In addition, S&P 500 values have risen an average of 13% after the government resumed operations.. While the immediate impact on equities may be negative, lasting effects are minimal.

Government Shutdowns: Impact On The USD

In contrast to stock valuations and economic growth, budgetary woes for the federal government directly impact the value of the USD. A prolonged shutdown can lead to several potentially bearish influences on the dollar, including credit downgrades, increased U.S. national debt and international liquidity challenges.

It is important to remember that projections regarding the aggregate influence of a shutdown depend greatly upon estimates and approximations. In the event that economic growth rates do eventually suffer, investor confidence in the USD may erode. Likely repercussions are spiking short-term exchange rate volatilities and a reevaluation of long-term investment plans as the data becomes public.

In 2013, a standoff between then-President Barack Obama and Congress led to an extended federal closure of 16 days. Upon the shutdown becoming official on 30 September 2013, the USD exhibited weakness pertaining to concerns over the U.S. government's debt ceiling and its ability to meet financial obligations. Subsequently, the forex session of 30 September 2013 was not kind to the USD against the forex majors:

The immediate price action facing the USD in 2013 was significantly bearish upon the shuttering of U.S. federal agencies. However, this pattern did not hold true for the closure of 2018-19. USD valuations flourished upon the shutdown becoming official on 21 December 2018:

The performance of the USD was strong upon the announcement of the 21 December 2018 partial government closure. Aside from the near-flat session posted by the USD/JPY, the dollar increased its value against the world's major currencies. Nonetheless, the following 31-day shutdown period from 21 December 2018 to 21 January 2019 presented a much more complex scenario:

Past Performance is not an indicator of future results.

Although the shutdown weighed on the minds of currency traders, a variety of market fundamentals also influenced exchange rates during this period. As an example, the losses sustained by the USD vs the GBP were largely a result of volatility brought on by the Brexit transition process. Commodity pricing, regional economic performance and the evolving policy of the U.S. Federal Reserve were several primary market drivers that impacted the relative value of the USD.

Undoubtedly, the U.S. government shutdown of 2018-19 piqued the interest of forex participants. However, it served as only one part of the larger market dynamic and was not the only determinant of the USD's relative value.

The 2019 U.S. Federal Government Shutdown Ends

On 25 January 2019, President Trump signed a temporary agreement to reopen the U.S. federal government for business. While far from a permanent solution to the ongoing budgetary standoff, the order ended the shutdown at 35 days, making it the longest in modern American history.

The bipartisan agreement was widely touted as being a political compromise regarding the issue of immigration, specifically construction of a physical barrier at the U.S.-Mexico border. Aside from the political ramifications, the agreement gave lawmakers an opportunity to complete the following tasks:

• Craft a "stopgap" spending bill to immediately restore governmental functions
• Meet payroll obligations for 800,000 federal employees furloughed or working without pay
• Debate, negotiate and design a viable 2019 U.S. federal budget

The economic impact of the 35-day partial shutdown was widely viewed as being severe. Aside from negatively influencing U.S. GDP growth for the first quarter of 2019, estimates of the pending fallout brought uncertainty to the forex, futures and equities markets. The following are a few of the more dire projections stemming from the shutdown:

• Standard & Poor's (S&P): A price tag of more than US$6 billion in aggregate economic cost was a product of the shutdown.
• Trump Administration: Internal estimates quoted a 0.13% reduction in quarterly GDP for every week of the shutdown. This figure was revised upward from an original value of 0.08%.
• JP Morgan CEO: Jamie Dimon, head of JP Morgan, was quoted as saying "U.S. GDP growth could go to zero" amid an extended shutdown.
• Credit Downgrade: A credit downgrade to AA+ by Standard & Poor's became a possibility, as was previously done following the 2013 government shutdown.

While concern was being shown by major media outlets and a broad spectrum of financial heavy-hitters, performance in the U.S. equities markets remained strong. For the shutdown period of 22 December 2018 to 25 January 2019, the three largest U.S. stock indices posted decisive gains:

The late-December/January rally evident in the U.S. stock indices was a stark contrast to the mixed performance of the USD for the same period. This point was reinforced by an exceptionally weak 25 January 2019 forex session for the USD against the majors:

January proved counterintuitive. Values lagged against the majors, with the government's reopening failing to inject optimism into the market. Given the looming 15 February 2019 deadline for a budget resolution, traders and investors were skeptical that another shutdown could be avoided.

On 15 February 2019, Congress passed and submitted an amended annual federal budget to President Trump for approval. However, it was announced one day earlier via Twitter that he would sign off on the budget once received.

Yet again, the dollar did not immediately respond well to news of the U.S. federal government resuming operations. The 14 February 2019 forex session was another instance of negative price action plaguing the USD across the majors:

Aside from rallies against the British pound and Canadian dollar, the USD struggled to find its footing. Although much of the uncertainty surrounding another shutdown was removed by ratification of the 2019 U.S. federal budget, USD values fell against five of the seven other major global currencies in the immediate aftermath.

Summary

The U.S. government shutdown of 2018/19 brought immediate volatility to the USD. Being the longest of its kind, the closure prompted traders to reevaluate the economic condition of the United States and potential fallout. Decreasing economic output, growing political division and general uncertainty were three factors that enhanced participation in the U.S. markets. If nothing else, the shutdown illustrated a deep political divide and served as a preview for the 2020 Presidential election cycle.