Understanding US Government Shutdown: What is Happening?

The threat of a U.S. government shutdown is looming once again. Although Congress averted the shutdown through a last-minute compromise, the danger is not completely gone since it is just a 45-day funding bill. What is a U.S. government shutdown, and is it going to happen? In this blog post, we’ll break down this recent phenomenon and discuss its potential impact on the forex market and traders.

What is a Government Shutdown?

A US government shutdown is more than just a bureaucratic hiccup; it’s a major event in the American government. It occurs when Congress fails to pass legislation that funds government operations and the President signs it into law. When this happens, the government resorts to continuing resolutions to temporarily extend funding.

Without funding legislation, federal agencies are forced to stop non-essential activities, and most federal employees will not receive their paychecks. The consequences of a shutdown extend far beyond government offices, affecting services, markets, and the broader economy.

Why Does It Happen This Time?

Government shutdowns often result from political disagreements within Congress. These disputes usually revolve around how to allocate funds within a predetermined budget. However, recent standoffs have centered on spending caps set just months earlier, adding complexity to the situation. House Republicans, for example, argued that these caps were too high, while Senate Republicans joined Democrats in advocating for increased spending. As a result, even top-line budget figures remained uncertain, worsening the crisis.

Recently, President Biden signed the temporary 45-day bill to avoid a government shutdown. Yet, the threat remains due to the deep division within Republicans and the contrasting priorities between major parties.

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The Real Crisis Looms

Beyond the immediate budget battle, the United States faces a severe fiscal crisis that often gets overshadowed by political drama according to The Economist. The deficit has skyrocketed to an astonishing $2 trillion, equivalent to 7.4% of GDP. Such deficit levels are typically reserved for wartime or economic recessions. The federal debt has exceeded 120% of GDP, and the fund supporting Social Security benefits is rapidly depleting, posing a threat of significant benefit cuts.

Did It Happen Before?

Yes, government shutdowns have occurred 21 times in the past. The longest shutdown took place four years earlier, 2019, during President Donald Trump’s tenure. This extended shutdown resulted from his refusal to accept Congress’s compromise of $1.6 billion in exchange for his demand of $5 billion to fund the promised border wall with Mexico.

Government shutdowns also happened during the Obama administration in October 2013 due to issues related to Obamacare. Additionally, there were two shutdowns during the Clinton administration in 1995-96. These occurred because of disagreements on various budget-related matters, including spending priorities, tax cuts, and proposed reductions in programs like Medicare and Medicaid.

How Does the US Government Shutdown Affect Currencies?

According to Bloomberg, the US dollar has become a safe haven amid concerns about potential fiscal recklessness and rising Treasury yields. It has gained over 2% in September, while alternative safe-haven assets like the yen, Swiss franc, and gold have experienced losses of more than 2%. Yields on US government bonds are rising to multiyear highs, thus, the dollar’s demand is higher thanks to interest rates and growth disparities. The yen is on track for its third consecutive annual loss, down more than 10%.

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Forex traders must closely monitor the evolving situation because it can lead to increased volatility and trading opportunities in the forex market, especially for USD currency pairs. The government shutdown’s impact can ripple through financial markets, affecting various currencies and assets.