FED UP WITH THE SHUTDOWN / THE WALL STREET JOURNAL

HEARD ON THE STREET

Updated October 2, 2013, 10:02 a.m. ET

Fed Up With the Shutdown

Federal Reserve This Time Isn't Likely to Take a Sanguine View of the Standoff

By JUSTIN LAHART

 

Investors are using the back-to-back U.S. government shutdowns of the mid-1990s as a guide to how markets and the economy will behave this time around. The Federal Reserve isn't.

The Fed's decision against reducing bond purchases when it met two weeks ago hinged on a variety of factors. But the now-realized potential of a shutdown over funding the 2010 health-care law, as well as the coming battle over raising the nation's borrowing limit, clearly played a role.

"I think that a government shutdown—and perhaps, even more so, a failure to raise the debt limit—could have very serious consequences for the financial markets and for the economy, and the Federal Reserve's policy is to do whatever we can to keep the economy on course," Chairman Ben Bernanke said at his postmeeting news conference in mid-September.

Contrast that to the Fed's behavior around the two government shutdowns that occurred in late 1995 through early 1996. Not only did the Fed refrain from commenting on these publicly, transcripts from its December 1995 and January 1996 minutes show policy makers weren't at all worried that the budget standoff between then-President Bill Clinton and Republican House Speaker Newt Gingrichmight hurt the economy. That stock market wasn't worried, either; the S&P 500 gained 4% during the period spanning the shutdowns.

In itself, the current shutdown shouldn't put much of a dent in the economy: J.P. Morgan estimates that each week the federal government is closed will shave 0.12 percentage point off the quarterly annualized growth rate of gross domestic product. This doesn't, however, take into account secondary effects that lost confidence could have on consumer and business spending.
These could be substantial if the fight over the shutdown morphs into a fight over raising the debt ceiling. The longer the shutdown lasts, the shorter the odds of the country going into default on debt will seem.

One reason financial markets have been so blasé about Washington's latest imbroglio—the S&P 500 is just 2% below the record it hit last month—may be a perception the Fed will step in to support the economy if things get out of hand. Moreover, even if Washington breaks a few windows, global fixed-income investors still think the U.S. would be one of the better houses on a pretty miserable block.

Indeed, Mr. Bernanke's comments suggest the central bank wouldn't merely delay winding down its bond-buying program. It could undertake additional action. In that case, investors betting on what many see as an inevitable rise in long-term yields could be caught offside.

So, Treasurys have so far taken the shutdown in stride. Plus, the budget fights of the past few years have convinced investors that they have seen this movie before, points out Robert Barbera, co-director of the Center for Financial Economics at Johns Hopkins University. The politicians will take things to the brink, and then pull back.

What investors are forgetting, he says, is that they aren't just spectators at the movie. They play a key part in a key scene—the one where market distress helps persuade Washington to end the impasse.

The longer it takes for that to happen, the more severe the damage could be.