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Wall Street’s fraught, lucrative world of betting on Washington

When lawmakers take a new policy position, tweet about a bill or vote “yes” or “no” on any piece of legislation, Wall Street is watching.

At The Vault, we translate Washington to the financial world. But this time, we’re flipping things around to highlight one key way that Wall Street and others in the business community have their sights on Capitol Hill.

Let’s be blunt: There are many, many millions of dollars at stake as Congress hurtles toward a government shutdown.

And the U.S. economy continues to sit in a strange spot. Years of mammoth federal spending from both the Trump and Biden administrations has dampened Capitol Hill’s appetite to dole out more dollars in 2023 and beyond. But even as the Fed has hiked rates at a historically fast pace in response to inflation, the jobs market has held strong.

So when it comes to the spending fight happening now in Congress, traders on Wall Street see a potential turning point in long-term U.S. fiscal policy. Whatever happens is sure to reverberate at home and around the world.

“To me, this is potentially a key moment,” one trader told us. “It’s less about shutdown or no shutdown — you could have the same effect on fiscal spending if Democrats agree to compromise” with House Republicans.

In the world of macro trading, keeping tabs on D.C. developments can be as central as tracking bond yields. Some firms’ investment strategies revolve around just a handful of singular events, like the Fed’s interest rate moves or whether federal antitrust regulators will crack down on mergers.

For instance, if a fund wants to bet that U.S. interest rates will keep going up, it might short sell tranches of two-year Treasuries. If another fund thinks the Inflation Reduction Act’s impact on clean energy is overhyped, it could short solar and wind energy companies.

The strategy partly revolves around relationships with a cadre of current or former Washington insiders tapped to help make crucial and timely decisions.

It’s a bold approach when it comes to Congress. There are few sure bets in the nation’s capital, where U.S. lawmakers prefer to drag out even the most critical, basic pieces of legislation to the eleventh hour.

The question for many traders with this current fight isn’t so much about whether the government shutters, even though a prolonged shutdown can shave some basis points off the country’s GDP.

The real focus will be the nature of a deal that gets struck between Democrats and Republicans, and whether that shifts the trajectory of American fiscal spending in a meaningful way.

If Democrats hold their own and Speaker Kevin McCarthy blinks, the macro environment probably won’t change too much. But should the clash result in even tighter limitations in federal spending than we saw after the summer’s debt ceiling fight, it could have an impact on everything from Treasury yields to longer-term corporate profits.

For a sector whose bottom line can make-or-break over small changes in the bond market, significant fiscal policy shifts could represent billions of dollars. Rest assured Wall Street will be holding its microscope over the dome.

— Brendan Pedersen

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Editorial photos provided by Getty Images. Political ads courtesy of AdImpact.