US stocks shrug off the government shutdown

Last week Congress failed to approve a bill to continue funding government operations. But US equities have largely ignored the fuss, hitting yet more record highs.

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Washington is dysfunctional, but markets are used to that by now

In 2017, the US administration's tax cuts "had investors celebrating the news out of Washington", says Justin Lahart in The Wall Street Journal. "This year will be different." The past few days have seen the first US government "shutdown" since 2013. Last week Congress failed to approve a bill to continue funding government operations (it has to keep agreeing short-term deals because it hasn't hammered out a budget to cover the entire fiscal year).

During a shutdown non-essential operations are suspended and some government workers go on unpaid leave. Early this week, however, the deadlock was broken. Democrats in the Senate agreed to funding until 8 February in return for some Republican concessions on immigration.

US equities have largely ignored the fuss, hitting yet more record highs. Quite right too, says Christopher Beddor on Breakingviews. There have been 18 such episodes since the 1970s. The economic impact is slight and the median movement in the S&P 500 index over the past 18 shutdowns has been zero.

A new headache for investors

There is a longer-term cost, however, continues Beddor: these episodes "encourage harsher political posturing", entrenching division and legislative gridlock. The increasingly rancorous atmosphere could prove especially awkward over the next few months.

The debt ceiling, an artificial constraint on how much Washington is allowed to borrow, will need to be lifted next month. The government would theoretically run out of money to pay its bills if the opposition, using the issue as leverage, refuses to let it borrow more. The US came close to a default during a debt-ceiling dispute in 2011. Partisan strife could also stymie co-operation between Donald Trump and Congress over trade, "raising the odds of the US pulling out of trade treaties", adds Justin Lahart. For all these reasons, the political backdrop is likely to prove a headache for investors this year.

Watch out for inflation

Still, equity markets have learnt to deal with Washington's dysfunctionality over the years. A bigger problem for markets, especially now that the improving data suggests the US is set to enjoy "a good old-fashioned boom", is inflation, says Robin Wigglesworth in the Financial Times. As growth accelerates, inflation will edge closer to 3%, a level that has historically severely rattled both bonds and equities. The official gauge is still just 2.1%, but here's a statistic worth bearing in mind: the New York Fed's measure of inflation, which is considered especially good at pinpointing cyclical turning points in underlying inflation, is just below 3%.

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