The United States government has shut down five times since 1990, and each instance has had a significant impact on the bond market. While the reasons for these shutdowns are varied, there is one consistent trend that has been observed: rates volatility tends to rise in the days leading up to the start of the shutdown and decline following its resolution. In this blog post, we will delve into the data behind this phenomenon and explore the potential implications for bond investors.

Data Analysis

To better understand the relationship between government shutdowns and bond market volatility, let’s take a closer look at the data. The chart below illustrates the movement of the MOVE index, which measures the volatility of the US corporate bond market, over the past six government shutdowns:

As the chart shows, rates vol tends to rise in the days leading up to the start of the shutdown, with an average increase of 2.7bps over the prior seven trading days. This increase in volatility is likely due to investors becoming more risk-averse as the possibility of a shutdown approaches, leading to a decrease in bond prices and an increase in yields.

Following the resolution of the shutdown, volatility tends to decline, with an average decrease of 3.9bps in the subsequent seven trading days. This decrease in volatility suggests that investors breathe a sigh of relief as the political uncertainty surrounding the shutdown subsides, leading to a return to more stable bond prices and yields.

Causes of Increased Volatility

So, why do rates volatility tend to rise during government shutdowns? There are several factors that could contribute to this phenomenon:

1. Political Uncertainty: The possibility of a government shutdown creates political uncertainty, which can lead to a decrease in investor confidence and an increase in volatility.
2. Risk Aversion: As the shutdown deadline approaches, investors may become more risk-averse, leading to a decrease in bond prices and an increase in yields.
3. Liquidity Concerns: During a government shutdown, liquidity in the bond market may be impacted, leading to increased volatility as investors struggle to buy and sell bonds.
4. Expectations of Resolution: As the shutdown deadline approaches, investors may begin to price in the likelihood of a resolution, leading to a decrease in volatility as the political uncertainty subsides.

Implications for Bond Investors

So, what are the implications of this phenomenon for bond investors? Here are a few key takeaways:

1. Diversification is Key: Given the unpredictable nature of government shutdowns, it’s important for bond investors to diversify their portfolios to minimize exposure to political risk.
2. Monitor Political Developments: Keeping a close eye on political developments can help investors anticipate and prepare for potential shutdowns, reducing the impact of increased volatility on their portfolios.
3. Flexibility is Crucial: Bond investors should consider maintaining some liquidity in their portfolios to take advantage of potential buying opportunities during periods of heightened volatility.
4. Long-Term Focus: While short-term market fluctuations can be unpredictable, bond investors should maintain a long-term focus and avoid making emotional decisions based on short-term political developments.

Government shutdowns can have a significant impact on the bond market, leading to increased volatility in the days leading up to the shutdown and a decline in volatility following its resolution. By understanding the causes of this phenomenon and taking appropriate steps to manage risk, bond investors can better navigate these unpredictable events and achieve their long-term financial goals.