As of late, financial markets have been gripped with the reality that the US government may be headed toward a shutdown due to Congress’s inability to pass the federal appropriations bill for the upcoming fiscal year, which begins on October 1st. The situation is still fluid as we write this, but given the importance of the situation, we feel as if we should highlight potential impacts on bitcoin and crypto markets at large.
If it appears that federal government shutdowns are becoming increasingly common, it's because they are. Over the years, there have been 10 instances of funding shortfalls leading to furloughed federal government employees, some lasting only a few hours. However, in the last decade alone, we've experienced three shutdowns, one during President Obama's term in 2013 and two under President Trump in 2018 and 2018 - 2019, resulting in furloughs for many federal employees. The most recent shutdown, spanning from December 2018 to January 2019, holds the record as the longest in history, lasting for 35 days and costing the government an estimated $5 billion.
Unfortunately, it is incredibly challenging to estimate the duration of a possible shutdown as it will be determined by the negotiations of lawmakers and will continue until a spending agreement is reached. However, based on historical data, shutdowns seem to follow a bimodal distribution. Most of them have been relatively brief, lasting anywhere from less than a day to 5 days (n = 7), while a few have extended for a duration of 16 - 35 days (n = 3). If we were to make an educated guess, considering the political polarization between the left and the right, which has progressively intensified over time, it is likely that this shutdown would fall towards the longer end of the spectrum.
On Monday, Moody’s, the only major rating agency to still have a AAA credit rating on the US, warned that a government shutdown would likely have negative repercussions to its rating. Whether that might result in a negative outlook or downgrade is still open for debate, but the ratings agency is concerned about the US’s weakening fiscal policymaking procedures amidst rising debt costs associated with rising interest rates. Another ratings agency, Fitch, downgraded the US’s credit rating one notch in August.
The concern expressed by Moody's about the US is not a recent development, however. In the 2011 downgrade by Standard and Poor's (S&P), which occurred in the wake of debt ceiling negotiations, the ratings agency also highlighted similar concerns regarding US policymaking. S&P's press release stated:
More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.
While the S&P downgrade was the result of the political wranglings around raising the debt ceiling rather than passing a fiscal budget, these comments ring as true today as they did 12 years ago.
We mention Moody's credit warning and S&P's 2011 downgrade to emphasize the potential impact on the markets. We previously discussed this issue amidst the debt ceiling negotiations earlier this year, which were postponed without a real solution. The 2011 downgrade had a disastrous effect on the financial markets. Fitch's downgrade last month went mostly unnoticed, except from drawing sharp remarks from the administration, and a downgrade from Moody's might not unsettle the markets as much as S&P's did in 2011. Nonetheless, it is unlikely that a government shutdown will be viewed positively.
In the event of a government shutdown, there are two critical areas that could face significant consequences, directly impacting crucial events in the crypto industry: law enforcement, chiefly the Department of Justice (DOJ), and financial regulation, chiefly the Securities and Exchange Commission (SEC).
Regarding the DOJ, a potential furlough could cause delays in legal cases. However, as per the DOJ's contingency plan in the event of a government shutdown, the majority of employees would be exempted from a furlough. Out of the 114,521 staff members, a significant number of them, 96,666 or 84%, would not be affected by a furlough. This exemption is attributed to the department's crucial role in ensuring the "safety of human life and protection of property." The same applies to law enforcement agencies like the FBI and criminal court proceedings.
On the other hand, the situation is completely different when it comes to financial regulators. Specifically, in the case of the SEC, its staff would be drastically reduced according to their government shutdown operating plan. Out of their total workforce of 4,604 employees, only 437, which is just 9.5%, would be retained to protect property and assist in law enforcement activities. Consequently, any registration statements or requests for exemptive relief, including those necessary for exchanges to list and trade ETFs, will not be approved. However, this in no way alleviates the responsibility of meeting response deadlines as mandated by the law. As a result, the SEC has resorted to emergency tactics in order to avoid having to either approve or reject innovative financial products, such as crypto ETFs.
Regarding spot bitcoin ETFs, the SEC has already initiated delays in making decisions for most ETFs, including those with response deadlines out into November. This includes the highly watched iShares Bitcoin Trust from BlackRock. This suggests that the SEC is preparing for a potential prolonged shutdown and aims to grant itself maximum flexibility in the approval process. We anticipate renewed interest in a spot ETF once a federal budget is signed into law and employees come back from furlough, but not before then.
Ultimately, the SEC will need to decide on the entire spot bitcoin industry by January 10th, 2024. This deadline is significant as it pertains to the Ark 21Shares product, which has the earliest final decision deadline. We believe it is possible that the SEC will adopt a consistent approach for all ETFs in the process, avoiding favoritism, and either approving or denying them all at the same time.
The futures-based and spot-based Ethereum ETFs present a slightly different story. It seems that the Ethereum futures ETFs are on the cusp of launching, with VanEck and Valkyrie recently updating registration statements to ensure they become effective before the SEC's hiatus. However, when it comes to the spot Ethereum products, the SEC shows no interest in even considering them at this time. The agency swiftly postponed the decision on the spot ETFs, some of them the same day they hit the Federal Register, bouncing them to the next deadline.
Despite the anxiety surrounding the federal shutdown or perhaps benefitting from it, bitcoin managed to end the week with a 1.9% increase. This performance comes despite the setback in the spot ETF decision timeline, which will have to wait until employees return from a potential furlough. While bitcoin may have received a boost amidst concerns about the US's creditworthiness, gold, a long-standing fiat hedge, didn't fare as well, falling 2.9%. As worries about slowing economic growth and signs of consumer stress grow, investors continued to sell down stocks, resulting in a 1.3% decrease in the S&P 500 and a 0.2% drop in the Nasdaq Composite. Bonds also experienced a decline, with investment grade corporate bonds falling by 0.9%, high yield bonds by 0.1%, and long-term US Treasuries by 2.2%. On the other hand, oil saw an increase of 2.3% due to continued tight supply.
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Oct 12 - September CPI reading
Oct 13 - SEC appeal deadline in Grayscale case
Oct 27 - CME expiry
Nov 1 - FOMC interest rate decision
Jan 10 - Final ETF decision deadline for the first spot bitcoin ETF, Ark 21Shares
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