September 25, 2023

By Hunter Hammond, Capstone lead Congressional analyst

With government funding on the verge of expiration next week when the fiscal year closes, a muddy political path forward, and dwindling time for a temporary spending measure to keep federal agencies operating, Capstone believes a government shutdown on October 1, 2023, is more likely than not—but only barely.

Capstone believes a government shutdown on October 1, 2023, is more likely than not—but only barely.

If a shutdown occurs, we think it will likely last only a few days to at most two weeks. Our view is broken down into the following probabilities:

• No Government Shutdown: 45%

• Government Shutdown: 55%
  
  
  • Short Shutdown (1-14 days): 40%
  • Extended Shutdown (15-29 days): 10%
  • Prolonged Shutdown (30+ days): 5%

Shutdown Facts and Impacts

On October 1, 2023—the start of fiscal year 2024—the government runs out of money, and without action from Congress, the government will shut down. Many federal workers will be furloughed, leaving all but the most necessary government functions in a holding pattern. During a shutdown, the Bureau of Labor Statistics will stop releasing key inflation and employment data. But for the most part, the economic impacts will be muted. To be clear, a government shutdown is not a debt limit breach and will not force the US to default on any debt instruments. The government has shut down six times since 1990, with the longest lasting 35 days at the end of 2018 and early 2019. Since 1976, the average shutdown has lasted roughly eight days, while the median shutdown has lasted just three days.

What happens in the coming weeks will likely drive outcomes for an end-of-year spending package, the vehicle that a plethora of non-funding-related policies typically ride along with.

While the economic significance of a potential shutdown is less meaningful to investors, we believe the political significance should not be ignored. What happens in the coming weeks will likely drive outcomes for an end-of-year spending package, the vehicle that a plethora of non-funding-related policies typically ride along with. Moreover, whether and how a shutdown is avoided will likely impact which person leads House Republicans going forward.  

How We Got Here

At the start of this year, Representative Kevin McCarthy (R-CA) became Speaker of the House after 15 rounds of voting. To do so, he made many concessions to the most conservative wing of the party, including the ability for any member to force a vote on a motion to vacate. If a majority of the House votes for that motion, Speaker McCarthy will lose his speakership.

Soon after taking the gavel, Speaker McCarthy engaged in debt limit negotiations with the White House. The House Freedom Caucus, a small but vocal faction of conservatives, demanded significant spending cuts—bringing spending back to FY2022 levels and allowing it to increase only 1% for 10 years—along with border security policy, work requirements in many safety net programs, defunding the IRS, ending some green energy subsidies, and generally limiting federal regulatory authority. However, the deal Speaker McCarthy ultimately struck with the White House did none of that. The Fiscal Responsibility Act kept spending at FY2023 levels, limited spending growth for only two years, and included modest permitting reform. Coming out of the negotiations, Freedom Caucus member Rep. Ralph Norman (R-SC) explained, “We got rolled on the debt ceiling. We’re not gonna get rolled again.”

Because of the razor-thin Republican majority in the House, five members can essentially tank any bill or rule on the House floor if Democrats are also opposed. Several Republicans have been doing just that in the past couple of weeks. On two occasions, Speaker McCarthy has brought up a vote on a rule to debate defense spending, and five or more Republicans have killed the rule. For reference, “Nancy Pelosi, John Boehner, and Paul Ryan never lost a single rule vote during their combined 15 years as speaker,” according to Punchbowl News. The conservative wing of the House Republican conference is being obstinate and flexing its power, disrupting operations in the House.

Where We Go Next

Capstone believes that if you secretly polled lawmakers in the House and Senate, somewhere between 250-300 House members and 75-90 Senators would favor a short-term continuing resolution (CR) at existing spending levels with additional funding for disaster relief and Ukraine support. However, a minority of the House Republican conference is adamantly opposed to this type of deal, and several members are likely opposed to any CR.

Considering these dynamics and the concessions made at the beginning of the year, Speaker McCarthy has no good options. If he avoids a shutdown, his speakership is in jeopardy.  If he causes a shutdown, he bears responsibility for the political headwinds.

Option A: If Speaker McCarthy puts a clean CR with disaster and Ukraine funding on the House floor, it will likely pass with a majority of Democrats, but then conservatives will attempt to take away his speakership.

Option B: If he puts a CR with significant spending cuts and no disaster and Ukraine funding on the floor, 1) it might not pass because some conservatives just do not want any action and Democrats will not support such a bill, and 2) if it passes, the Senate will gut the bill and return a clean version to the House, putting Speaker McCarthy in the same spot as Option A.

Option C: If Speaker McCarthy does nothing, the government will shut down, and Republicans will bear the responsibility for all of the negative political impacts, namely the military, border patrol, TSA, air traffic control, and many other personnel not getting paid. If a shutdown lasts long enough, mortgage and rent payments will be missed, workers will walk off the job, parks will stay closed, and the basic functions of government will deteriorate.

Unpacking Capstone’s View

The DC consensus is that a shutdown is imminent, and betting markets place a roughly 71% probability of one happening. Directionally, that is probably right. That said, as noted previously, we’ve only experienced six government shutdowns since 1990, which helps us establish our base rate of shutdown per fiscal year at 18% over the past 33 years. However, the chaos in the House Republican caucus leads us to increase our probability to 55%. Importantly, Senate Republicans and moderate House Republicans are also very aware of the political conundrum we described above. They do not want to be associated with a shutdown. Further, a majority of members in both chambers are on board with a clean CR, in our opinion. Finally, there is precedence for passing single-day or several-day CRs to buy time. All of those features lead us to believe that a shutdown, if it occurs, will not last long. Eventually, we think one or multiple of the following will happen:

• Senate Republicans will lean on the Speaker and their party members in the House to put a clean CR on the floor
• A majority of House Republicans will oppose the Freedom Caucus, ensure Speaker McCarthy that they will defend his gavel, and get a floor vote on a clean CR
• Speaker McCarthy will find a compromise on a very short-term CR, extending government funding for only days at a time
• Speaker McCarthy will acquiesce and put a clean CR on the floor, knowing that his speakership is in jeopardy
• House Democrats and a minority of House Republicans will sign a discharge petition and take control of the House floor, putting a clean CR up for a vote

The DC consensus is that a shutdown is imminent, and betting markets place a roughly 71% probability of one happening. Directionally, that is probably right.

Whether one of those options is exercised next week to avert a shutdown or soon after a shutdown as political pressure builds, we believe one will happen. With most of Congress in favor and the negative political consequences of a shutdown for Republicans, we believe either a shutdown will be avoided or—more likely—lasting only a few days to no more than two weeks.

The ensuing political fallout remains to be seen, but we believe it will be meaningful no matter what.  Capstone will pay close attention to the dynamics at play for our corporate and investor clients.

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