Shutdown fears loom over Wall Street after McCarthy ouster

The war within the House GOP has thrown another wrench into financial markets. 

Wall Street experts say the political dysfunction behind former Speaker Kevin McCarthy’s (R-Calif.) ouster poses new risks at a time of already heightened fears as the Federal Reserve walks a careful line in its efforts to tamp down inflation. 

Skyrocketing bond yields and turmoil in oil markets are also drumming up fears of a recession, giving investors plenty to worry about in the months ahead.

“Yields and oil are the big stories. Those have the biggest economic consequences. And they’re coming at a time when the economy’s especially fragile,” said Callie Cox, U.S. investment analyst at eToro, in a Wednesday interview.

“But these political headlines aren’t helping things and they probably are making investors more jittery, even though the economic impacts are likely to be more limited.”

The Dow Jones gained 127 points on Wednesday, rising 0.38 percent, while the S&P 500 rose 0.81 percent and the Nasdaq rose 1.35 percent. Those gains came after a steady decline in stocks in recent days and weeks, including a 400-point drop for the Dow on Tuesday.

That followed an ugly September for markets as lawmakers came within hours of allowing the government to shut down over the weekend.

While Congress ultimately managed to pass a short-term stopgap measure, the shutdown threat continues to loom large. The stopgap bill, also known as a continuing resolution (CR), runs through Nov. 17, giving lawmakers a matter of weeks to reach a new deal on government funding. 

Now, the House faces the added obstacle of electing a new Speaker before it can move forward with the spending battle.

“The selection process to choose a new Speaker will further delay work on the individual appropriations bills so Congress will be faced with a choice (again) of passing another CR or shutting down the government,” said Brian Gardner, chief Washington Policy Strategist at Stifel Investment Bank, in a statement.

“A new Speaker could face the same problem that faced McCarthy — a small group of House Republicans who have leverage and are willing to use it to force a shutdown,” he added.

Most government shutdowns are brief and have little direct economic impact. But Wall Street experts remain concerned that a shutdown could shake consumer confidence.

“We’ve seen big drops in consumer confidence in some of the most recent shutdowns, and at a time like this — where consumers have a lot to think about  — that drop in confidence can have a real effect on spending,” Cox said.

The U.S. economy has been remarkably resilient after years of high inflation and rapid Fed rate hikes meant to cool it down. While job growth has slowed slightly, the labor market remains strong and Fed officials expect the economy to avoid a recession, according to their most recent projections.

Even so, consumer confidence has been declining since the summer, and a recent spike in gasoline prices has taken a toll on U.S. households.

“There’s always that worry that a drop in confidence could be enough to break the camel’s back and actually reduce spending enough to put the economy into crisis,” Cox said.

Another shutdown could also deprive the Fed and markets of crucial economic data as the central bank faces a difficult crossroads in its fight against inflation.

After peaking at a 40-year high of 9.1 percent last June, inflation has eased significantly, falling to 3 percent this June before ticking up slightly in July and August. The Fed warned of the possibility of further rate hikes last month, as inflation remains above its 2 percent target.

Fed officials are weighing whether the central bank should hike interest rates again before the end of the year or ease off as the economy shows signs of slowing. 

The Fed will be paying close attention to federal economic data — particularly from the Department of Labor — as officials mull whether to keep putting pressure on the economy.

A lapse in government funding would stall those reports and policymakers from getting the latest view into the economy. The Fed is funded independently and would continue to operate in a government shutdown, but without crucial information.

“When it comes to the shutdown … the principal issue is cutting off the data, and that’s very scary to the bond market in an environment in which the Fed is regarded as a wild card,” said Daniel Alpert, managing partner at investment firm Westwood Capital.

“Let’s just say we had a government shutdown over the weekend, there would be no jobs report on Friday,” Alpert said, referring to the upcoming October employment report. 

“That would have been a complete disaster. Nobody would have known what to do, and everybody sort of runs for cover.”

It could be weeks before House Republicans elect a new Speaker, and there is no guarantee they will do so before the Nov. 17 government funding deadline. Until then Rep. Patrick McHenry (R-N.C.), the chairman of the House Financial Services Committee, will serve as Speaker pro tempore.

McHenry is a familiar name to Wall Street as the top Republican on the House committee with jurisdiction over the financial sector. Alpert suggested that an agreement to keep McHenry in charge of the House could assuage some of the market turmoil.

“It would be an extremely stabilizing outcome,” Alpert said. 

“Quite frankly, if [House Minority Leader Hakeem] Jeffries [D-N.Y.] was a great leader, he’d be sitting with McHenry in a backroom right now making the deal.”