Current spending laws for the funding of federal operations run until this Saturday (30th September) – the end of the US Federal Government’s fiscal year. Meaning that Congress needs to approve new funding by the 1st October to avoid a Federal Government shutdown.

What a shutdown involves

A shutdown would result in the suspension of all non-essential work by federal agencies. Non-essential workers would be furloughed during the shutdown – but would receive back pay once the shutdown is resolved. Essential functions including the payment of social security checks would continue.

The government would continue to service its debt (in contrast to a debt ceiling breach).

Possible partial solutions

If a full deal is not agreed in time, there might be a short term deal agreed (a “continuing resolution”) that would push the issue into next year. Congress could also pass some appropriation bills to fund parts of the government – as happened during the 35-day shutdown in December 2018/January 2019.

Effects on inflation and rates

A shutdown would affect the economy and consumer spending. It could result in reduced inflation pressures, and so reduced need for rate increases – by directly reducing output and impacting consumer sentiment.

This said, it could also create supply side disruption from delayed government inspections or other channels – which can add to inflationary pressures. Reduced demand for US assets during this uncertainty could also depress the dollar and result in import-driven inflationary pressures.

On balance, the downside pressures on inflation and rates are likely to be materially greater than upside pressures for a short shutdown. If the shutdown lasts for a longer period of time, this could begin to change.

A shutdown could also result in delays on the release of economic data – increasing inflation expectation and interest rate volatility at a time when markets are already particularly sensitive to data.