Morgan Stanley Explains The 'Beautiful Shutdown' Scenario

The government's partial shutdown has now gone on for four days.

And while it's a shame that Congress refuses to make a deal to get the government back online, the economic damage may be putting enough pressure on the economy that the Federal Reserve will have no choice but to keep stimulating via easy monetary policy.

This could be a positive for risk assets.

Morgan Stanley's Hans Redekar wrote about it today:

'Beautiful' shutdown scenario. The VIX index has shot up to 17, showing its highest reading since June as investors use the options market to hedge bullish exposure. However, unless the US defaults, the combination of the government staying closed and the related economic slowdown prolonging monetary accommodation is probably the most bullish long-term outcome for risky assets, explaining why investors prefer hedging the short-term downside risk instead of reducing physical portfolio exposure into risky assets. Currency markets will see USD weakening as long as this scenario plays out, in our view.

But as Redekar notes, a debt default would change everything.

Default scenario. However, should the US default, then there will be a radical change in FX markets. A US default will increase USD demand inside and outside the US, pushing USD sharply higher. However, between now and November 1, the market will play the 'beautiful' shutdown scenario, slowing the US economy sufficiently to keep the Fed in the QE game for longer. Interestingly, Asian equity markets have started to outperform US markets, suggesting that funds are leaving the US looking for better risk/reward elsewhere.

Morgan Stanley's house view continues to be that the U.S. government will not default.

It'll be interesting to see how events unfold as we approach the Oct. 17 deadline for the debt ceiling.