One thing I’d say about the potential implications of a government shutdown on the bond market is that I think it’s probably a mistake to see Treasury interest rates as primarily driven by default risk. If the government of El Salvador or Illinois borrows dollars, it might in the future run out of dollars and not repay its loan. But there’s no reason the government of the United States should ever run out of dollars. It makes the dollars.
An increase in Treasury borrowing costs could be driven by hope or by fear. In the “hope” scenario, if investors increase their view of the growth outlook they’ll become more willing to invest funds in things other than bonds and thus bond interest rates will have to go up. There’s also a fear scenario, which would probably be about the value of the dollar. If you lend the US government some dollars, you’re definitely going to get back the number of dollars that the US government promised you. But right now a dollar buys you about 0.70 euros and maybe five years from now it’ll only buy you 0.65 euros, in which case lending euros to the Dutch government might look like a better bet than lending dollars to the USA. That would drive interest rates up, but it still wouldn’t be default risk.
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