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On the latest edition of Market Week in Review, Senior Director and Chief Investment Strategist for North America, Paul Eitelman, discussed the potential market and economic impacts of a U.S. government shutdown. He also explained the key reasons behind the U.S. Federal Reserve’s (Fed) change in rate-cut expectations for 2025.

Markets unlikely to be fazed if U.S. government shuts down
Eitelman began with a look at the latest political developments in the U.S., where the risks of a partial federal government shutdown increased after President-elect Donald Trump voiced his opposition to a bipartisan bill that would have kept the government funded through mid-March. Republicans in the U.S. Congress scrapped the bill after the president-elect’s remarks, Eitelman said, leaving lawmakers until the end of the day on Dec. 20 to pass a revised budget deal. If Congress cannot agree on a new bill by then, the U.S. government will officially shut down at 12:01 a.m. on Saturday, Dec. 21, he noted.“Among other things, the president-elect has called for the revised bill to include an increase in the debt ceiling, which was last raised in June 2023,” Eitelman said. He noted that the debt ceiling—or federal borrowing limit—is currently suspended through Jan. 1, 2025, but is scheduled to be reinstated the following day.Eitelman said that if the government is partially shuttered on Dec. 21, the impacts to U.S. markets and the economy are likely to be limited. “Historically, U.S. government shutdowns have not been a major source of risk for financial markets. The transmission channels from a shutdown onto the economy are transitory and, by now, well understood, given that there’s been six shutdowns in the past 34 years,” he stated.Eitelman explained that during a shutdown, federal government workers are furloughed or—in the case of essential employees like air traffic controllers—asked to work without pay. While this creates a short-term disruption to household income, the norm is for Congress to provide full back pay to workers once the shutdown ends, he said. “In macroeconomic terms, this distortion creates a pothole for economic growth—on the order of 0.1 to 0.2 percentage points for each week the government is closed—with a full recovery shortly thereafter.There is no lasting imprint on fundamentals, which is why there is typically no lasting imprint on markets,” Eitelman stated.All in all, during U.S. government shutdowns, investors are typically better served by taking a long-term view and focusing more on other risks and opportunities, he remarked.

Fed adjusts rate-cut outlook, rattling markets
Pivoting to the Fed, Eitelman noted that after delivering another 25-basis-point (bps) rate cut, the central bank lowered its projections for 2025 rate cuts from four to two at its Dec. 17-18 meeting, sparking a selloff in markets.The downturn in U.S. equities was among the sharpest of the year, he said, with the Dow Jones Industrial Average plummeting 1,123 points, or 2.58%, while the S&P 500 Index dropped by nearly 3%. U.S. government bonds also sold off notably, Eitelman said, with the yield on the benchmark 10-year Treasury note surging above 4.5%.He noted that the Dec. 18 selloff cleared the optimism in equities that the Russell Investments strategist team had been seeing in its measure of market psychology, with sentiment shifting away from overbought levels and closer to neutral levels.“A more balanced sentiment picture is good news for the market outlook. The Fed is still trying to support a sustained expansion, but it’s being more careful now,” Eitelman remarked. He explained that the central bank’s revised rate-cut projections are partly due to the resilience of the U.S. economy and partly due to the belief that the federal funds rate is now closer to the so-called neutral rate—the rate at which monetary policy neither speeds up nor slows down the economy.Ultimately, the Fed’s 2025 rate outlook suggests it’s entered a new phase of the easing cycle, where the bar for rate cuts will be higher than before, Eitelman said. “This doesn’t mean the Fed won’t cut in 2025—in fact, we still expect two rate cuts next year—but it does suggest that central-bank leaders will take a more careful approach to adjusting monetary policy in the year ahead,” he concluded.More By This Author:Key Takeaways From The Latest Round Of Central Bank Meetings
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