Can the federal budget be passed without the threat of a government shutdown?

After Congress delayed final passage until March 2024 for the fiscal year that began on October 1, 2023, it finds itself up against another budget deadline. The current fiscal year ends on September 30, 2024. Congress must act by October 1, 2024, for the government to keep operating.

Budget battles are nothing new in Washington, though the process required to finally push forward appropriations for fiscal year 2024 were out of the ordinary. Congress extended budget allotments several times before approving final funding measures nearly six months after the fiscal year began.

“If the past is any guide, it’s likely that matters will get kicked down the road before final budget action occurs,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. He expects Congress to pass temporary budget extensions that will push action beyond the November 5 elections.

While federal government spending agreements can be contentious, federal spending declined in recent years after peaking in the immediate wake of COVID-19’s emergence in 2020.

Along with approving a budget, Congress faces an additional deadline to extend the federal government’s debt limit. The debt limit affects the U.S. Department of the Treasury’s ability to issue additional debt to finance government expenses. Debt issuance is required to fund deficit spending that exceeds current tax receipts. The debt limit suspension ends on January 1, 2025. In lieu of timely Congressional action, the Treasury Department, as it had to in 2023, may be required to implement “extraordinary measures” to maintain government operations and avoid a shutdown.

Given Congress’ sharp political divisions, it’s likely that the process of approving the fiscal year 2025 budget and the debt extension could again face obstacles. Investors can expect delays in Congress approving final measures on both counts.

Yet markets today are primarily attentive to fundamental factors – the strength of the economy, Federal Reserve interest rate policy, and corporate earnings – more than the state of the election or the Congressional budget process. “Congress will have to get very close to a deadline that risks a government shutdown before markets will be much focused on budget matters,” says Haworth. Congress is in recess until early September.

A strained political environment

The political realities of the makeup of Congress add to budget process challenges, according to Kevin MacMillan, head of state and federal government relations at U.S. Bank. “With Republicans having a slender majority in the House of Representatives and Democrats a slim majority in the Senate, there is only a narrow path to the ultimate budget resolution.” Several recent changes in Republican House membership, including resignations, reduced its already-slim House majority. In the Senate, Democrats have an effective two-seat majority.

November’s elections could alter party control of Congress. One-third of the 100 Senate seats are on the ballot this year, and Democrats have to hold onto a number of contested seats to maintain Senate control. All 435 House seats are up for election, and only a handful would need to shift to Democrats for the party to gain control of the House of Representatives. The next Congress won’t convene until January 3, 2025.

“A small but vocal group of House members sees the budget process as an opportunity to object to further government funding and pursue other aspects of their political agenda,” says MacMillan. Eventually, Republican leadership in the House and Democratic leadership in the Senate agreed to a 2024 budget plan that passed both houses of Congress and that President Joe Biden signed. With elections resulting in new members joining Congress in 2025, and a new president in the White House, the fiscal year 2025 budget process could be muddled.

Federal government shutdown precedents

Federal government shutdowns are not a new phenomenon. Since 1980, the federal government has partially shut down on at least 10 different occasions. Between 1980 and 1986, four shutdowns occurred lasting only one day. Three other shutdowns extended just 3-5 days. Since 1995, however, three government shutdowns occurred that lasted much longer.

Source: United States Congressional Record.

Economic and market considerations

The biggest concern for investors is the risk of an extended government shutdown. “Although it’s an event that can create short-term hardship for those employees who are furloughed, the long-term impact of past shutdowns hasn’t tended to be broadly significant for the economy,” says Haworth. “Even if there is a temporary decline in economic activity, it hasn’t been a major concern for investors.”

But Haworth also notes that the appearance of dysfunction in the policymaking process may have an impact on how bond rating agencies view the status of U.S. government debt. On August 1, 2023, Fitch Ratings downgraded its Long-Term Foreign-Currency Issuer Default Rating for the U.S., from its long-standing AAA rating to AA+. Among other factors, Fitch cites “repeated debt-limit political standoffs and last-minute resolutions (that) have eroded confidence in fiscal management.”¹ More recently, the bond-rating firm Moody’s lowered its outlook on the U.S. credit rating from “stable” to “negative.² Haworth notes, however, that the potential impact of these downgrades is uncertain. “Even if the U.S. government’s credit rating is downgraded, there’s nowhere else for investors to go to invest in debt securities of higher quality than U.S. government debt.”

Haworth also sees little lasting market risk if a shutdown isn’t avoided. “The history of shutdowns is limited, but the data shows no definitive market reaction to these events, either as the market anticipates it, while the shutdown is underway, or after it is resolved,” says Haworth.

Source: U.S. Bank Asset Management Group.

In all three instances of extended shutdowns, markets managed positive performance during and immediately after the shutdown. In two of the three instances (1995 and 2013), markets performed positively in the months leading up to those shutdowns. In 2018, markets were down prior to the shutdown, but other contributing factors may have been at play, including the Federal Reserve’s decision to hike short-term interest rates during that period.

“A variety of issues impact the markets, even during stressful times like government shutdowns,” says Haworth. “But ultimately, investors are focused on more important fundamental factors such as corporate earnings and market valuations.” Haworth says given the frequency of government shutdown threats; they seem to have a limited impact on the markets. “The market won’t start pricing these in until we actually see a shutdown, and a financial impact from it,” says Haworth.

Keeping your investment strategy on track

While political issues such as the debt ceiling dispute, federal government budget impasse as well as the upcoming presidential election cycle can garner significant headlines, it’s important for investors not to allow these issues to distract them from long-term investment objectives.

Talk with a wealth professional to discuss your current portfolio to make sure your assets remain properly positioned to meet your financial goals consistent with your time horizon and risk tolerance.