Here’s What To Expect For Stocks If There’s A Government Shutdown…

Ok, everyone can rest easy because Senate Majority Leader Mitch McConnell said on Monday that there is exactly “zero chance” of  Congress not raising the debt ceiling by late September.

Of course when it came to explaining how exactly it was he came to that conclusion he was short on answers.

Needless to say, (another) new debt ceiling crisis couldn’t possibly come at a worse time. Trump has had an impossible (literally) time advancing his agenda since his inauguration thanks in no small part to his own ego and seemingly intractable propensity to shoot himself in the foot at each and every turn.

Whatever political capital he had left was lost during last Tuesday’s comically egregious press conference in which the President regaled the nation with his concerns about Confederate statues, berated reporters with rhetorical questions about George Washington, and at one point demanded to know how everyone in attendance felt about Thomas Jefferson.

So if anyone asks you why this time is more dangerous than last time when it comes to the debt limit, that’s why.

A couple of weeks ago, we brought you some color and a chart from Deutsche Bank who took a look at what the VIX did during two previous episodes of debt ceiling drama. For those who missed it, here are the excerpts:

Equity market reacted during [the] two [previous] episodes as VIX increased from 13 to 20 in 2013 and from 16 to 25 in 2011 (and rose further as the eurozone crisis worsened in August 11). So far, nothing seems to be priced in this market (see graph). It is worth noting that in both cases, financial markets seems to have given the benefit of the doubt until up to two weeks ahead of the deadline.

Well on Monday afternoon, Goldman is out with a cross-asset look at what happened during the 2013 government shutdown. You’ll recall from yesterday that the bank thinks the chances of a repeat are about 50%. More below…

Via Goldman

This week’s focus: The debt limit & government shutdowns

September will likely be a pivotal month for US legislative progress to be made, given our economists project the debt limit should be reached near the end of that month and the next expiration of congressional appropriations is September 30. Should Congress fail to extend appropriations, a government shutdown would result. Our economists believe there is a 50% chance of a brief government shutdown occurring. However, their view is that the prospect for disruption is greater from the debt limit not being raised than from a short government shutdown.

The last time a US government shutdown took place was from October 1-16, 2013, which was around the time of a debt limit deadline. US equities sold off roughly 4%, but during the government shutdown risky assets inflected and began to recover and rallied until the end of the year, boosted by supportive macro at the time. This is different to the debt limit crisis in 2011, when equities fell almost 20%. However, this was during the Euro-area sovereign debt crisis and the ISM manufacturing fell by 10 points.

Given legislation should eventually be enacted and growth is still strong, we would not expect a similar risk-off event this time. However, with generally elevated policy uncertainty, equities might stay more volatile as we near the debt limit deadline. High equity valuations already increase latent risk of drawdowns and cap potential returns from here – our US strategists see limited upside over both 3 and 12 months. We are Neutral equities over 3 months (still OW over 12 months).