Institute Alert

• We believe the two chambers of Congress are unlikely to strike a compromise by tomorrow’s (September 30) midnight deadline for a continuing resolution (CR) to extend the 2025 fiscal-year budget. A shutdown seems likely beginning October 1, impacting nonessential functions of the government’s discretionary spending.
• We believe that a shutdown will have only a small and transitory economic impact, but it may spur some financial market volatility, especially if delays in government economic reports obscure the path of Federal Reserve (Fed) interest-rate cuts.

• We prefer to look through this additional noise from Washington and instead view any equity-market pullback as an opportunity to incrementally add exposure to our favored cyclical and growth sectors: Financials, Information Technology (IT), and Industrials.

Congressional gridlock has struck again, leaving the government grinding toward a potential shutdown beginning October 1 — the start of fiscal-year 2026. To avert a shutdown, both chambers of Congress still have until midnight on Tuesday night (September 30) to pass a temporary, stopgap funding measure known as a continuing resolution (CR). The House already passed (by way of simple majority vote) a short-term CR that would fund the government at current levels through November 21. To become law, however, it must also pass in the Senate, where 60 votes are required to avoid a filibuster. This means at least seven Democratic votes are needed — and possibly more if any Republican senators vote against the stopgap funding measure.

Earning the necessary votes remains a challenge in the Senate because Democrats view this as a rare opportunity to impose political leverage, given their minority governing position. This time, there are a few specific issues on the bargaining table, mainly centered around goals to restore — and prevent further cuts to — health care spending.

Senate Democrats are pressing for the extension of enhanced Affordable Care Act (ACA) subsidies (set to expire at year end), the reversal of Medicaid cuts enacted under this year’s One Big Beautiful Bill Act (OBBBA), and the reversal of the administration’s spending rescissions strategy, which has imposed a freeze on foreign aid, state grants, and other funds already approved by Congress.

One plausible path to compromise would be a short-term CR that gives Congress time to negotiate sticking points, such as the following:

• Lawmakers could opt for a limited extension of ACA healthcare subsidies in return for a gradual unwind of ACA tax credits for the highest earners, thereby avoiding big ACA premium increases in a midterm election year.
• A Republican demand for increased spending on security for federal officials may be part of an agreement.
• It remains unclear what sort of compromise could be crafted on reversing OBBBA Medicaid cuts, which amount to more than $1 trillion over 10 years, including the ACA subsidies.
• Presidential spending rescissions may be less of a roadblock to a compromise, as they already face legal challenges and some Republican opposition that make additional moves by the president difficult.

Despite a path for a quick compromise, the duration of this potential shutdown in a highly partisan environment remains an important question for markets. While there is debate as to which party would take the blame for this shutdown, any further hit to consumer confidence (typical during any government closure) would not be a welcome development for either party heading into midterm elections.

If a shutdown occurs, it will be confined to nonessential functions of the government that are part of the roughly 26% of government spending funded through discretionary spending. Unfunded federal agencies will halt nonessential functions, but essential services related to public safety (like air-traffic control) or national security will keep operating. That’s also true of mandatory government spending ― Social Security checks and Medicare benefits would continue to be distributed. Likewise, the U.S. Treasury should continue to pay scheduled interest and principal on government securities, given the priority assigned to those payments during past government closures.

Government shutdowns historically have had very limited economic effects. The 2013 episode was a full shutdown because, like this time, Congress had not yet approved any of the 12 appropriations bills before the deadline. However, in the December 2018 – January 2019 impasse, Congress had passed five of the 12 funding bills, so the shutdown was only a partial one, albeit the longest on record at 35 days.

Whether a full or partial shutdown develops this time, we believe the primary economic growth risk is for a small reduction that the economy should largely recoup after a budget or CR is passed. Still, we think it’s worth noting that a full shutdown also delays official economic data, like the September reports on nonfarm payrolls (job creation) and Consumer Price Index (CPI) inflation¹, complicating efforts by a data-dependent Fed to determine monetary policy.²

Historically, equity markets have focused on long-term earnings prospects and have demonstrated resiliency during past shutdown episodes — particularly during brief government closures. Given this history, along with our constructive economic outlook, we prefer to look through this additional noise from Washington and instead view any equity-market pullback as short-lived and as an opportunity to incrementally add exposure to our favored cyclical and growth sectors: Financials, Information Technology (IT), and Industrials. We also rate the more traditionally defensive Utilities sector as favorable, in part as a backdoor way of gaining exposure to the secular data-center buildout tied to artificial intelligence.

Beyond stocks, prior shutdowns have not shown a consistent or significant impact on interest rates. Past periods of uncertainty, due to disruption of data releases or uncertainty over policy determined by a data-dependent Fed, have temporarily triggered a brief flight to quality, benefiting perceived safe-haven assets like gold along with U.S. Treasury securities and other high-quality debt. For example, the yield on the benchmark 10-year U.S. Treasury note fell from nearly 2.80% on the eve of the government shutdown that began on December 22, 2018, to 2.55% by January 3, 2019, then rebounded to 2.75% when the shutdown ended 22 days later. This time, it’s also worth noting that the debt ceiling was lifted in July and is not a complicating factor in the current negotiations on Capitol Hill. We view this as another reason to look through any political impasse on the 2026 budget. We continue to prefer a selective approach to bonds, prioritizing quality and the intermediate portion of the yield curve with maturities ranging from three to seven years.

¹ Scheduled for release on October 3 and October 15, respectively.

² The next Fed policy decision is scheduled for October 29.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. Investments in gold and gold-related investments tend to be more volatile than investments in traditional equity or debt securities. Such investments increase their vulnerability to international economic, monetary and political developments. They are also exposed to the risk of severe price fluctuations in the price of gold bullion.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

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