Investors wary on Washington, balancing debt ceiling

The economic boost from an expected $1 trillion infrastructure bill working its way through the US Senate has helped push Wall Street stocks near record levels, but some investors are concerned that the next two months in Washington could be rocky.

At issue is not only the bipartisan infrastructure bill, but an expected $3.5 trillion in proposed spending in a Democrat-led reconciliation bill. There is also a showdown coming over the debt ceiling, which could lead to a federal government shutdown if a deal is not reached to increase the borrowing limit by October.

Few expect the US government will default on its debt and upend the $22 trillion Treasury market. Still, some analysts say a drawn out debt ceiling fight could increase volatility in a US stock market where valuations have become stretched with prices near record highs. Other worries include a looming unwind of the Federal Reserve's easy money policies and a resurgence of Covid-19 that threatens to dent growth.

"When I look at Washington I see a lot of risk," said Steve Chiavarone, a portfolio manager and equity strategist at Federated Hermes.

He said he is concerned political posturing around the debt ceiling could escalate ahead of the 2022 Congressional elections, and that the reconciliation bill could boost corporate or individual tax rates, weighing on investor sentiment.

As a result, he is holding cash in anticipation of adding to value or cyclical stocks that may fall during a market sell-off, he said.

Overall, global fund managers increased their cash positions in July from 3.9o 4.1 per cent of assets while adding to shares of large technology companies, according to Bank of America Merrill Lynch. At the same time, options markets indicate that investors see limited gains in the months ahead, according to Barclays.

Esty Dwek, head of global market strategy at Natixis Investment Managers Solutions, said that she has also been raising cash to reposition for more volatility in the months ahead.

"We now have less visibility into the second half of the year" given the emergence of the Delta variant of the coronavirus and the potential for higher taxes as part of a broad reconciliation bill, she said.

The rising sense of concern comes as investors anticipate possible further details on plans to pull back emergency-level supports of the economy from the Federal Reserve at the Jackson Hole annual conference of central bankers.