US shutdown brings market turbulence but also opportunity
As Washington barrels toward another government shutdown, investment experts are watching closely; not just for signs of resolution, but for what comes next.
The disruption, which hinges on ongoing gridlock between Republicans and Democrats over federal spending, is drawing sharper scrutiny from bond markets than in previous cycles. And for institutional investors, particularly those in fixed income, the stakes may be higher this time around.
Christine Tan framed the current US government shutdown threat as a familiar political standoff, but one complicated by deeper divisions and a lack of meaningful negotiation. While shutdowns have occurred before, most notably in 2013 and 2018, she noted that this one stands out because "both parties haven't really spoken,” explaining that the usual process, tabling and passing a budget by the end of the fiscal year on September 30, is now stalled due to wide gaps in spending priorities.
“The reason why it feels particularly urgent this time around is because the two parties are very far apart in terms of priorities,” said Tan, portfolio manager at Sun Life Global Investments. “There are some who view this as the Republicans potentially using these negotiations to shrink the government in a way that the Department of Government Efficiency - or DOGE - was not as effective in doing. So that’s the problem. You have both parties that aren’t just far apart, but they have very specific goals that are pretty much at odds with each other.”
From the Republican side, the emphasis is on shrinking government and cutting taxes, while Democrats are focused on preserving healthcare funding, especially Affordable Care Act subsidies. Tan also raised concerns about the GOP potentially using the shutdown to enact permanent changes to the federal workforce.
From an investment perspective, Tan noted that equity markets typically take a relatively calm view of US government shutdowns, often treating them as short-lived disruptions and “tend to be pretty complacent,” she said, pointing out that in previous shutdowns, equities rose from the start to the end of the event.
While some short-term volatility is expected, particularly as markets digest political headlines, Tan said investors are largely unfazed because the impact on corporate earnings is minimal. The bond market, however, may react differently. Tan suggested that if furloughs of federal employees were to become permanent, that could be interpreted as giving the Federal Reserve more leeway to ease policy.
She underscored that US Treasuries are insulated from the risks of a government shutdown.
“The shutdown will not impact continuing payments or servicing of US government bonds or debt,” she said, emphasizing that investors should not confuse a shutdown with the threat of default.
Richard Polsinello also agreed.
“You’re not really going to see anything affected in terms of the credit worthiness of the US,” said Polsinello, senior market strategist at Franklin Templeton Institute, highlighting that the country has already been downgraded a notch by major rating agencies.
Meanwhile, Dustin Reid, VP and chief fixed income strategist for the Mackenzie Investments Fixed Income Team acknowledged that while markets initially ignored the threat of a shutdown, sentiment has since shifted quickly over the last week.
That concern has already been reflected in Treasuries, he explained. The 10-year yield failed to break above the key 4.20 per cent level and instead moved lower, with buyers stepping back into the market.
“We’ve seen 10-year Treasuries from a yield perspective move back down towards 4.10. And I think not all of it, but a lot of it is because of the concern over the potential shutdown and the impact it’ll have on the economy,” Reid noted.
He stressed that this episode is unusual because investors are trading the shutdown risk more seriously than in past cycles, likely due to the White House’s suggestion that non-essential workers could be fired rather than furloughed, which “has a more permanent, sparring downside impact on the economy,” he warned.
Reid believes institutional investors are likely to look past headline noise and instead focus on secondary indicators, paying more attention to what he calls “the B-tier data,” adding that the real question is whether markets overreact to shutdown risks.
Since past shutdowns have been short-lived, measured in days or weeks, Reid argued that sharp moves could present entry points depending on the asset class.
Polsinello dismissed speculation of heavy foreign selling for the 10-year Treasury, emphasizing that it hasn’t materialized. He noted that yields have held in a narrow band, and he expects that to continue.
In the near term, he expects turbulence across markets and disruptions in economic reporting. These gaps, he said, could cloud the Fed’s policy outlook at a time when unemployment is creeping higher and inflation remains stubbornly above target.
Overall, he sees Treasurys staying range-bound for the next three to six months, with shorter maturities anchored by Fed policy and the long end harder to predict, hovering in the high-4 per cent range.
While shutdown-driven volatility is uncomfortable, it could also create buying opportunities for disciplined investors, according to Polsinello. With equity valuations stretched and credit spreads unusually tight, a temporary shakeout might allow investors to re-enter at more attractive levels.
“Any type of pullback that we get, whether that’s in the equity market or the fixed income market, that could actually pose the opportunity to invest in levels that are a little bit better than what we’ve seen right now,” he said.
Still, he cautioned against underestimating the risks. The administration oversaw the longest shutdown in decades, and Polsinello warned this one could again drag on. The biggest near-term issue, he said, is the hit to household spending from furloughed federal workers.
Ironically, he added, a rise in unemployment tied to the shutdown could give the Fed justification to ease more aggressively. That would ease the pain in the long run, even as short-term volatility unnerves markets.
Still, he also cautioned against assuming this shutdown will mirror past ones. While markets have often looked through these disruptions, he argued the divide between Democrats and Republicans this time around is unusually wide.
“There’s just such a chasm in between how the Democrats feel about things and the direction of the country and where the GOP is trying to take this,” he said.
He expects short-term volatility and uncertainty to dominate until the political deadlock is resolved.
