Parts of the federal government have been shut down since Tuesday, but the stock markets don't appear to be losing any sleep over the lack of services. Not only was the past week pretty quiet on Wall Street, but the Dow Jones Industrial Average (^DJI +2.32%) and S&P 500 (^GSPC +2.21%) were both up over the past month as the shutdown loomed.
Worry about the shutdown hasn't hit Wall Street but there are a few reasons investors and every citizen should start being concerned about the budget showdown and why it will impact markets over the next few weeks.
A hit on growth
At a time when economic growth is already slow, a government shutdown doesn't help. A Bloomberg survey of economists this week predicts GDP growth will slow by 0.1% after only a one-week shutdown. That may seem like a small amount of growth but when you consider that the U.S. economy is a $15.7 trillion behemoth, 0.1% is about $15 billion in lost growth. That's a lot of growth to be giving up for the shutdown.
We may never know the exact economic impact the government shutdown will have on the economy but even a small hit on growth will be significant.
Defaulting on debt
Listen to financial gurus and they'll tell you that defaulting on U.S. debt is not an option, but that's exactly what might happen if the government shutdown continues. Treasury Secretary Jack Lew says we have until October 17 to raise the debt ceiling or risk default.
What would happen if the U.S. defaults? Well, treasuries are the benchmark for everything from corporate debt to mortgages, which would all become more expensive overnight. I wouldn't be shocked to see a 1% or more rise in rates if a default happens, although predicting the exact impact is impossible because it's never happened before.
The other side effect of rising rates would be a drop in bond values. You may hold bond, whether they're corporate or treasuries, in a retirement account and a jump in rates would hit the value of those bonds immediately.
In short, a default would be terrible from Wall Street to the smallest Main Street in the country.
Uncertainty doesn't help anyone
Whether the shutdown lasts another hour or another month, there will be an impact on the certainty of investors and businesses. Decision makers in these areas like to know what the rules are going to be so they can plan their futures and events like a debt ceiling debate or a government shutdown bring up a lot of uncertainty.
It's times like these that companies pull back on hiring, investors decide to hold more cash than buy stocks, and consumers spend just a little less each month. The aggregate impact is slower growth and less hiring, which is bad for everyone.
So far, stock markets don't appear to be worried about these impacts because they seem impossible to fathom. We're 12 days away from a default and eventually cooler heads will prevail... right?
Don't be surprised if stock markets start reacting very differently to the debate as the shutdown wears on. By the end of next week, if there's not a deal, stocks could fall significantly because the downside risk for investors is very real, as I've pointed out above.
Foolish long-term investors should understand why Wall Street may panic over the debate in Washington, but also keep in mind that many short-term concerns provide buying opportunities, not a fundamental reason to sell wonderful companies. With that said, the next week on Wall Street might not be pretty, so hold on for the ride.
