It is still impossible to say if there is going to be a deal between politicians over the US debt ceiling. There has been no big market sell-off or spike in volatility, and a lot of money managers seem calm, as there is a hunch that the stand-off is basically a gambit that will result in an 11th-hour deal.
“I can only assume that this tomfoolery will be sorted out at the last possible moment, with a solution which pleases no one and is maximally craven," says one American hedge-fund manager based in Asia.
"If it doesn’t happen," he adds, "probably the world will go on as before, only debt will be more expensive and some people will go bust. And I shall burn my passport.”
If the default does take place – because, frankly, the US's Tea Party doesn’t really care much about what foreign alternative investors think – then in addition to passport burning, there may be a flow of money into assets perceived as ‘safe havens’. Such a flight to quality could see gold or (paradoxically) US Treasuries rising in value, and other financial assets being bought on dips.
The mechanism of a default may involve less pyrotechnics and excitement than the prospect seems to imply.
“‘Default’ is a slight misnomer," says lawyer Greg Heaton at Deacons in Hong Kong. In fact the US government would continue to pay its debts and interest when due, but may be unable to borrow more money, so might be unable to pay some of its other usual expenditures."
Still, hedge fund managers are mobilising their portfolios as the countdown clock ticks away, and are mindful that a resolution can mean several different things.
“If there is a short-term fix in the US, that would be good for equities,” says Eddie Tam, chief investment officer of the CAI Global Fund in Hong Kong. “However, if there is a full and complete long-term solution involving a debt reduction, then that could well be bad for equities, as it would imply cuts.”
It is ironic, then, that a real solution may have worse implications than a botched, temporary patch-up.
Tam adds that for the last quarter he has been defensive and has maintained a 30% net exposure for equities. His defensiveness is based not on the US issue, though, but rather the world’s wider issues, and his personal outlook envisaging 1970s-style stagflation.
He is keeping in his portfolio those investments he believes in, but may cut back on directional exposure as the deadline approaches, partially hedging with long-volatility positions and maybe some single-stock shorts.
"Our models are net long all but Hong Kong," says Robert Howe of alternative-investments firm Geomatrix in Hong Kong. "Markets are acting well, really, in spite of the calamitous outcome if the debt ceiling is not raised. It is such a binary outcome for share prices in a week’s horizon."
He adds that although he expects the debt ceiling to be raised, the risk-return scenario offers investors a poor trade-off. The upside to a successful political outcome is modest; the pain from a default, however remote, is likely to be great.