FYI | Nov 06 2012
By Andrew Nelson in Florida
The US presidential election is only a day away and in two days we’ll probably know who the winner is. House and Senate elections will also transpire, so by the time we know who will be US president for the next four years, we should also know which party holds a majority in both houses of Congress. Yet despite being only days away from some real, concrete answers, it will still be only the first of many steps that are needed to gauge the distance and height of the looming US fiscal cliff.
Over the course of the past few months the polls have gone from a dead lock on Obama, to neck in neck over the last month, then a swing back to the likelihood of an Obama victory that has been building over the past week or so. Ever since statistician Nate Silver picked 49 out of 50 states in the last election, I’ve been a bit of a fan. His FiveThirtyEight blog on the New York Times website has had Obama well ahead for the majority of the election season and now points to an 86.3% likelihood of an Obama re-election. I must say, the people at Fox News and MSNBC don’t like his math, so he is hardly an accepted source of objective truth, at least as far as the Right is concerned.
While the main spotlight may be on the presidential election, the election for Congress is actually more important when it comes to how the legislative process will unfold after 6 November. Much like Australia, the US requires that both chambers in the Congress – the House of Representatives and the Senate — pass new legislation. As of today, polls are indicating the House of Representatives is solid lock for a Republican majority, while the race is closer for the Senate. Most pollsters give the Democrats an edge in the Upper House, unless you read Nate Silver, who sees a more robust 91.5% chance of Democrats retaining the Senate.
Even if Democrats win the Senate and keep the Presidency, they will still be a long way away from having what is termed a “super majority”. This is a 60-seat (out of 100) or better majority, which allows that party to pass legislation in a much easier fashion, as it allows for the prevention of filibustering on the senate floor. So you know, filibustering is a tactic (often employed by Republicans over the last few years to bring about the current state of deadlock) that allows the opposition party to drag out a legislative process by simply holding the floor for however long it wants, thus delaying and likely killing the prospect of voting on a topic. Given the status quo will likely be maintained in both houses, new legislation will need to be backed by Senators from both sides of the house if it to get through Congress. We’ve seen how well that works over the past couple of years.
What we’re likely to end up remaining stuck with is what is called a divided government. This is where the two different parties control the two houses of Congress and the presidency. I’m hopeful sanity will prevail, but still view it likely we’ll see a continuation of the current unfriendly environment, with likely little in the way of compromise on key economic issues. This does not bode well for the US to navigate a safe path around or a modest fall from the looming fiscal cliff we’ve all been reading about.
Now here’s something you may not know. Regardless of who wins the election, fiscal cliff negotiations will probably start just after the election and given winners and losers don’t change seats until January, the post election fiscal cliff talks will be between the same people that have been having the pre-election fiscal cliff talks. Thus, like it or not, political uncertainty will remain a drag for the remainder of the year pretty much no matter what happens.
Senior analyst at Danish investment Danske Bank, Signe Roed-Frederiksen, expects a final deal on the fiscal cliff will probably happen by the 1 January deadline and we will see a fiscal contraction of between 1.1% and 1.4% of GDP next year. A 1.1% contraction scenario is most likely, with that implying an Obama victory, a Democrat Senate and a Republican house. Under this most likely scenario, the payroll tax cut would be left to expire, there would be tax increases to fund Obamacare, with the budget control act overturned and replaced by other savings.
There, of course, remains the risk a deal is not reached before 1 January and that the US does fall off the cliff as tax cuts are allowed to expire. On Danske’s numbers, this would imply a temporary fiscal contraction of more than 3% of GDP come 1 January. The probability of this scenario playing out is most likely if Obama were to win a narrow victory and the Republicans decide to drag out negotiations to give the President as difficult a start to his second term as the second half of his first turn was.
Either way, whatever happens, it’s likely to come right down to the wire before a deal is struck and the process will likely be just as ugly and economically unsettling as last year’s debt ceiling debates. Investors will once more be reminded of the ridiculousness of US policymakers and their inability in reaching political compromises when needed. Roed-Frederiksen thus expects US politics to remain a negative factor for risk sentiment in these final months of 2012 and ultimately expects the US to be downgraded once again by ratings agencies in the coming year.
As far as short term market reactions go, if we look at history, the market likes a Democrat win pretty much the same as a Republican win. However, the market performed better two out of three times in the last 50 years if an incumbent is re-elected.
For investors, the most likely eventuality is some near term challenge for risk markets and an environment supportive of government bonds and the USD. Were we to see a Republican sweep there would likely be a positive risk market reaction and a negative government bond and USD reaction.
On the issues of monetary policy, Danske expects risk assets to be better off in a status quo scenario. In terms of regulation policies, a Romney victory is better for risk appetite. Overall, Danske believes an Obama win would be a slightly better alternative for risk markets than Romney.
Ultimately, Danske sees a victory for either, with a split house, which as we’ve noted are the heavily favoured outcomes, as being neutral for near term equities markets. Rather, the progress of the fiscal cliff negotiation is the key to market sentiment. A Republican sweep is good for markets given the fiscal cliff can disappear, plus the Republicans intend to wind back Wall Street regulation and lift drilling restrictions.
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