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Traders work the floor at the New York Stock Exchange in New York. (ANDREW KELLY/REUTERS)

Traders work the floor at the New York Stock Exchange in New York.

(ANDREW KELLY/REUTERS)

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A government shuts, markets shrug Add to ...

On the first day of the first U.S. government shutdown in 17 years, investors took a jaded view of the latest standoff gripping Congress.

The risk aversion and flight to safety typically resulting from bouts of political paralysis were noticeably absent. Fear skipped this one.

“The investing community have been elevated to veteran status when it comes to disruptions, uncertainty and political dysfunction,” said Eric Lascelles, chief economist at RBC Global Asset Management. “I think the market is better able to slough over these things than it might have been a few years ago.”

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Failure to reach a budget compromise triggered a partial shutdown of the federal government on Tuesday, forcing as many as one million workers off the job and stalling some federal programs.

Fundamental disagreement on government spending has bogged down Congress ever since the Republican Party took control of the House of Representatives in 2010.

Partisan animosity turned fiscal disputes into outright standoffs over a potential government shutdown in April, 2011, the debt ceiling negotiations in August, 2011, and the “fiscal cliff” in December, 2012. In each instance, market volatility was quelled as eventual agreements minimized the economic fallout.

This time around, investors don’t seem in the mood to panic. Quite the opposite.

U.S. and Canadian stock indexes were up on the day, U.S. 10-year Treasury yields inched higher, and even the VIX volatility index, which is considered a gauge of investor anxiety, fell considerably.

The costs of a short suspension of government services alone wouldn’t be sufficient to change any economic forecasts. At about $300-million (U.S.) a day in lost output, the price of a one-week shutdown would amount to only about 0.1 of a percentage point of fourth-quarter GDP, Mr. Lascelles said.

The real threat of political gridlock is that it could imperil an agreement on raising the debt ceiling before the U.S. runs out of borrowing capacity on Oct. 17. “Running an immediate balanced budget would mean slashing outlays by more than $600-billion at annual rates, or roughly 4 per cent of U.S. GDP, enough to cause a recession if it persisted,” Avery Shenfeld, chief economist of CIBC World Markets, said in a note.

Investors clearly don’t think that is going to happen. At least not yet. Right now, they have every reason to think that legislators will come to their senses before it’s too late, Mr. Lascelles said.

“The basic line of thinking is that the public will be fed up with these political antics before the debt ceiling, limiting the ability of anyone to create real problems.”

Political brinkmanship has not gone over well among constituents and fear of voter reprisal is a powerful motivator, Mr. Lascelles said. “It has held us in good stead through some pretty scary times over the past few years.”

Others are leery of giving Congress the benefit of the doubt.

“Markets are thinking this is more noise than actual risk. I’m not so sure that’s the case,” said Michael Gregory, senior economist at BMO Nesbitt Burns.

A technical default whereby the United States must make selective payments is highly improbable and an outright default is even less likely, he said. But the risks are higher than they were a week ago.

“If there’s one thing the global financial crisis has taught us, very small probabilities of something really, really bad happening, can [have an] impact,” Mr. Gregory said.

Up to about two weeks of a government shutdown could be sustained before the costs begin to register as more than a rounding error and the debt ceiling deadline gets uncomfortably close. “A couple of weeks and people start to get nervous,” Mr. Gregory said.

Fitch Ratings warned on Tuesday that a failure to agree promptly to a debt ceiling increase could be met with a downgrade. That would align the ratings agency to Standard & Poor’s, which stripped the United States of its top-notch credit rating two years ago. “This sort of political brinkmanship is the dominant reason the rating is no longer ‘AAA,’” S&P’s research team said on Monday.

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