Trading Nation

Will Congress inadvertently halt a rate hike?

How government shutdown may affect stocks

Shutdown talk is again gripping Washington. With Congress heretofore unable to reach a budget agreement, the government should see a partial shutdown beginning Oct. 1. And that could be the real reason that the Federal Reserve won't raise rates, according to one strategist.

"In the end we probably won't get a shutdown, but the chances of a shutdown in the market's eyes will probably move from 5 to 10 percent, to 70 percent, back to 5 to 10 percent. And if you're a Fed governor on Thursday of this week, and you're looking at the risks, it's another reason to relax and hold off," said Larry McDonald, head of U.S. strategy at Societe Generale, in a Monday "Trading Nation" segment.

The central question for the market this week is whether the Fed will finally raise its federal funds rate target. For McDonald, the prospect of a government shutdown could alter the market's calculus.

"It would take about 0.2 percent off of GDP growth that quarter, so that's essentially like a rate hike," McDonald said. "The Fed governors will look at it like hiking rates, so therefore they'll hold off" on doing the same.

Read More These sectors could rally if the Fed stays put

Getty Images

Markets also may not take a rate hike well. Last time there was a shutdown, in 2013, the S&P 500 lost 5.5 percent and the VIX rose 70 percent in the period just before the shutdown to when the shutdown ended, said McDonald.

Currently, Congress needs to pass a continuing resolution in order to keep the government fully funded. While Republican Party leadership appears to be attempting to ward off that possibility, an effort on the part of conservatives to block federal funding for Planned Parenthood threatens to lead to a stalemate that would force a shutdown. 

With a solution unlikely before the Fed makes its call,  "the Fed cannot hike this week with political policy uncertainty on the rise," said McDonald.

The chances of a rate rise don't seem particularly high at the moment anyway. Traders only foresee a 25 percent chance of a September hike according to CME Group's FedWatch tool, a number that has been falling over the past few months.