The threat of a U.S. government shutdown in less than a month’s time is skyrocketing thanks to the struggles of the Republican Party inside the halls of Congress.

Back in late September, then-House Speaker Kevin McCarthy took the lead in passing a last-minute stopgap funding measure to avoid an earlier shutdown. McCarthy was ousted as Speaker on Oct. 3 in a historic move, the first time in the country’s history that a sitting speaker has been removed by a motion to vacate.

That’s a big problem for investors.

It was McCarthy’s deal to keep funding the government that led to his dismissal. Goldman’s head of research, Jan Hatzius, recently wrote, "We continue to view a shutdown in Q4 as the base case, likely when funding expires Nov. 17."

Recession now looks inevitable, and a shutdown would worsen it

The yield curve—a graph of interest rates across bond maturities—has been inverted since July 2022. That means 10-year Treasury rates have been lower than 2-year rates, indicating a recession is on the horizon.

In fact, the last six inverted yield curves have all accurately predicted recessions. Anything that cuts into demand like a potentially long-term government shutdown is likely to significantly worsen the recession that this signal says is imminent.

Shutdown-driven recession would be a “devastating blow to equities”

Several leading analysts are comparing the behavior of the stock and bond markets this year to their behavior right before the Black Monday crash of October 1987, when the market lost 20% of its value in one day.

SocGen investment strategist Albert Edwards told the Dow Jones, “The equity market’s current resilience in the face of rising bond yields reminds me very much of events in 1987, when equity investors’ bullishness was eventually squashed.”

He continued: “Just like in 1987, any hint of recession now would surely be a devastating blow to equities.”

In the run-up to a previous debt ceiling deal on June 3, the U.S. Treasury burned through its rainy-day fund. After the ceiling was lifted, the government had to replenish it—to the tune of more than $1 trillion.

That was one reason that the national debt hit a record $33 trillion in September, up by $2.2 trillion (7.1%) year over year.

The trouble is, there’s just not enough demand for all those Treasury bills and bonds the government needs to sell. That’s one reason long-term rates have gone up so much. The 10-year bond hit a 16-year high earlier this month.

Between now and Nov. 17, the government will have to find ways to fund military spending, and a range of entitlement programs not covered in McCarthy’s deal.

That rainy-day fund will need to be replenished again.

This doesn’t mean that the government will be overwhelmed by rising interest costs, at least not soon, since most of the debt it issues is long term. But those high rates will be hard on consumers right away.

Mortgage rates, for example, are tied to 10-year Treasuries and hit a 23-year high of 7.79% in the week of Oct. 26.

Nobody knows for sure if and how a recession will play out. But there are three problem scenarios investors should prepare for.

Problem #1: A shutdown-worsened recession

Depending on your level of wealth, experts say you probably need a rainy-day fund that can cover your expenses for six months if you lose your job. It should be held in an FDIC-insured bank savings account or CD, or with a reputable money market fund.

If recession is a concern, switching out of long-term bond funds and ETFs and into short-term instruments is considered more desirable because long-term bonds lose money more quickly than short-term bonds when rates rise.

If the yield curve is dis-inverting and returning to normal, long-term bonds will lose a lot of money and short-term bonds stand to outperform.

Problem #2: A recession-triggered stock market meltdown

If you have stocks that have been outperforming their expected value, a recession may be the time to start paring back those positions and take some money off the table.

If they crater, like similar ones did in the dotcom crash in 2000, it could take years to get back to the valuations you enjoy today.

Another helpful tactic is ensuring your stock and ETF positions have stop-loss orders, so if they begin to plummet, your brokerage will sell them automatically before you are wiped out.

Problem #3: Higher interest rates for longer

Sorry, you’re just going to have to live with these. There are no shortcuts to living with higher rates. But you can take heart from knowing that your savings are finally earning you a decent return.