The first thing to note is that this is different from the debt ceiling debacle that occurred a few months ago. A key element then centered on the risk that the US Treasury would run out of cash and be unable to make coupon and bailout payments on the public debt, which in turn risked a technical default. and potential significant instability in financial markets. In extreme cases, it could have crashed the system. It was also possible that parts of the government had been shut down back then to help prioritize debt service. In the end, these extremes did not occur, as the debt ceiling was eventually suspended (although a little too close to a potential default for comfort).
The government shutdown we’re talking about here is different, at least in terms of its impact on Treasuries. The Treasury can continue to issue debt to raise cash, so there is no risk to interest payments or bailout payments on public debt. Therefore, there is no risk of default on the debt. The important nuance here is that the Treasury holds the cash. The thing is that they don’t have the legal right to spend it beyond the end of September. For spending to continue unrestricted through October, Congress must pass the appropriate spending bills. Only the parts of the government affected by specific spending bills are affected, but that is broad enough to cause considerable pain to many government employees or Social Security recipients.
The impact of a shutdown of some parts of the government on financial markets focuses primarily on the dampening effect it has on economic activity. As a standalone matter, this should put downward pressure on Treasury yields. And the degree of severity would depend on how long the (partial) government shutdown lasts. There is also the potential for risk assets to worry as an element of macroeconomic uncertainty is introduced into the equation. This would also likely push cash into bonds and money market funds (and out of risk assets). However, it is important to note that there is no material incremental default risk for Treasuries, so the financial system should not come under pressure.
This also has a technical dimension. To the extent that the Treasury continues to issue in the bond markets and then spends less of the cash raised, a tightening of underlying liquidity conditions occurs. This may act as a bullish force for ultra-short-term rates. It shouldn’t be significant, but at the margin it acts as a sort of counterweight to the downward pressure on (longer-term) market rates. But it shouldn’t be a dominant influence. Either way, there shouldn’t be a huge impact, as long as it doesn’t get out of control in terms of the longevity of any (partial) government shutdown.