Peering Nervously Over The US Fiscal Cliff
Elections tend to spell uncertainty for the markets and none more so when they're too close to call such as the US one where President Barack Obama, a Democrat, is trying to see off contender Mitt Romney, a Republican, for a second term. But for the markets at least the election is almost a sideshow as the fiscal cliff looms far larger.
Obama – a known entity
An Obama victory may initially be greeted with relief by the markets, particularly those related to risk assets, such as precious metals and risk currencies like AUD and GBP – as it would spell continuity of policy. The Obama administration is likely to favour carrying on with more lax fiscal policies coupled with continued quantitative easing by the US Federal Reserve, which would imply a weaker US dollar.
Romney – the fiscal saviour?
Many commentators have speculated that a Romney victory would more likely lead to a resolution of the fiscal cliff as it would be easier for a Republican President to negotiate a deal with a Republican-dominated House of Representatives. But any resolution may not happen until next year earliest, which is when the new presidential term starts. A continuation of the Obama administration, on the other hand, could lead to prolonged and bitter negotiations with Republicans unwilling to gift him any credit for solving the fiscal cliff.
…..but what about his policies
So Romney would be good for risk assets? Not so fast, Romney is also an unknown quantity for the markets and that means uncertainty. He's talked more stridently in terms of tackling the US budget deficit and there is a high level of disapproval within Republican ranks over the Fed's monetary policies. This is all potentially deflationary, so good news for the US dollar, bad news for gold for example. However, he also wants tax cuts, to raise US defence spending and not tackle welfare entitlements too harshly though he wants to get rid of Obama's healthcare reforms. He talks forcefully of reducing government waste and improving its efficiency – laudable goals few leaders have actually ever meaningfully achieved. In other words a victory by either candidate is loaded with uncertainties.
Going full circle
However, Romney, if he wins, would soon be faced with a reality check, that the US economy is too weak to go on a strict fiscal slimming regime. It's likely a Romney administration would eventually bend towards being more fiscally lax and find continued monetary stimulus by the US Federal Reserve a convenient prop – in other words a not too dissimilar approach to Obama though the packaging would differ. The uncertainty would stem from how long it would take Romney to get there. So longer term Romney or Obama may not make much difference and QE 'infinity' would be bullish for gold.
Lacking a strong mandate
Another issue is that who ever wins will probably only do so by a fairly slim margin, which weakens the victor's mandate and that will make it harder to agree a solution over the fiscal cliff with the party in opposition. Lingering uncertainty over resolving the fiscal cliff will undermine confidence in gold and risk currencies. The Fed could respond with more quantitative easing, but has warned that it cannot compensate for such a big fiscal adjustment if it were to occur.
That dented can
Among the most like outcomes are some sort of partial fudge or a further kicking of the can down the road whereby it is agreed to temporarily halt the fiscal cliff to buy more time to negotiate a solution. Indeed, a dramatic event such as a stock market crash may concentrate minds in Washington and bring forward a solution sooner. However, the fiscal cliff could still occur and right now a grand bargain to resolve the issue doesn't look that likely before the end of the year.
The fiscal cliff contributes to already searing global uncertainty adding to the problems of the far from resolved Eurozone crisis and China's economic slowdown and power transition. In the meantime markets are likely to yo-yo nervously on every twist and turn of the negotiations over the fiscal cliff once the election is out of the way.