The U.S. government began its shutdown on Oct. 1, when Congress failed to pass appropriations for fiscal year 2026. The standoff continues between the White House and congressional Democrats with the predictable finger-pointing by both parties out front and center.
The shutdown takes on another dimension as government workers start to miss paychecks. The practical aspects of the shutdown have been nationwide flight delays, no help lines at the Internal Revenue Service, closed access to national parks, and other inconveniences. Workers considered essential to national security remain on the job, albeit unpaid.
And the Trump administration began laying off 4,000 workers on Oct. 10. The administration has tried to reconfigure funding to make payrolls for military members. At the same time, the White House is arguing that furloughed government workers are not entitled to back pay after the shutdown ends.
Is this a mess? Totally. Will the latest move on not restoring back pay end up in court? Absolutely.
What is the effect on the bond markets from shutdowns? We decided to look at the government shutdowns over the past fifty years. Then we decided to look at the effects on the bond markets from the shutdowns of the longest duration.
Let’s look at four shutdowns of longer duration. Dec. 16, 1995–Jan. 6, 1996 (21 days): This was over discussions on balancing the budget. Surprisingly, that happened during the Clinton administration, which was the last time we had a balanced budget. Republicans had a sweeping victory in the midterm elections in 1994 and were trying to flex their muscle. There was disagreement on estimates of revenues, and the two sides agreed to compromise on the use of plans. The 10-year bond yield dropped from 5.85% to below 5.60% and finished around 5.65% by the time the shutdown is over.
A government shutdown in 2013 lasted 16 days from Oct. 1 to Oct. 17. This was in the first year after President Obama’s reelection. This was a budget standoff over the Affordable Care Act (better known as Obamacare). The Republican-controlled Congress wanted to defund and repeal parts of the ACA, which had recently taken effect. The government eventually reopened without any substantive changes to Obamacare, reflecting the public opinion, which blamed Republicans for the shutdown.
The effect on the bond markets was mild, with the 10-year yield at 2.65% at the start of the shutdown, rising a little above 2.70% before finishing at 2.60% at the time the shutdown ended.
The third example is the 35-day shutdown that ran from Dec. 22, 2018, through Jan. 25, 2019, during President Trump’s first term. This shutdown, the longest U.S. federal government shutdown so far, was predicated on President Trump’s demand for almost $6 billion in funding for a wall along the Mexico-U.S. border. Democrats opposed giving that amount for a wall, arguing it was irresponsible. Trump refused to sign any spending bill that did not include funding for the wall. Eventually, the mounting pressure resulted in a temporary funding bill. Of further note was the Government Employee Fair Treatment Act of 2019, which guaranteed that furloughed government employees would receive retroactive pay (this will be brought up in the suits that are certain to follow the current shutdown).
The bond market reaction during that shutdown was a drop from a 2.80% yield on the 10-year U.S. Treasury to 2.55% before it finished near 2.70% at the end of the shutdown.
The current shutdown centers on Democrats insisting that expiring Affordable Care Act tax credits be extended, and they want to reverse proposed cuts to Medicaid. The prospect of missed paychecks but no back pay for furloughed workers makes this episode particularly ugly.
What has been the effect on the bond market so far? The 10-year Treasury was a 4.15% when this shutdown began. On Oct. 17, the 10-year Treasury closed at 4.00% amidst concern about bank loans. Our thoughts are that the headlines will seem to dictate some further drop in yields if the shutdown extends.
Why do Treasury yields drop? Our main thought is that shutdowns reflect the now often dysfunction of Congress. This one is no different (though the politics seem more noxious). Shutdowns breed uncertainty. Uncertainty among government contractors who do not get paid, workers who are furloughed and not getting back pay, and military members potentially not getting paid. Add long lines and travel delays.
In any case, as in other periods of uncertainty – wars, financial crises, pandemics, etc. – people look to the safety of U.S. Treasury bonds. This episode is no different. And the resolution will come when one side believes the political cost of continuing the standoff is not worth it. Midterm elections are a little more than a year away and primary campaigns are eight months away. No doubt that will bring its own pressures.
John R. Mousseau is Vice Chairman and Chief Investment Officer at Cumberland Advisors. Contact him at John.Mousseau@cumber.com or 800-257-7013, ext. 307.