International | Nov 08 2012
By Greg Peel
As of today we have a Democrat in the White House, a Republican majority in the US House of Reps and a Democrat majority in the Senate, just as we had the day before. The only difference is that the Republicans were hoping to alter the status quo yesterday, but didn't. Now they are stuck with a Democrat administration for four more years and this Congressional balance for at least two. Do they concede or do they fight?
At risk is the fiscal cliff. To recap, the fiscal cliff refers to the simultaneous expiry of income tax cuts for higher US earners and forced spending cuts (referred to in the US as “sequestration”) as at the beginning of 2013. The Acts created to secure these changes represent the deadlock reached this time last year between the parties which could not be broken, so instead negotiations were put off for one more year. As noted, the Republicans were hoping to be in charge by now, but they are not.
Republican House Speaker John Boehner suggested this morning his team is ready to compromise, but not concede. Commentators are not convinced. Wall Street is clearly far from convinced. The fear now is that the US will plunge over the fiscal cliff and into recession. Simultaneous tax hikes and spending cuts will ceteris paribus reduce debt, but the negative impact on GDP growth will threaten a fall in revenues to offset the chance to reduce debt.
“From an Asian perspective,” suggests Andrew Swan, BlackRock's head of Asian fundamental equities, “the major impact of the US presidential election will be on investor sentiment, primarily as it relates to the impending fiscal cliff”. The automatic spending cuts equate to a 5% budget reduction, Swan notes, which will “clearly be negative for the US recovery and the associated Asian export market”.
Given the deadlock in Washington, Swan believes a compromise will be difficult to achieve. The trade-off, however, is that under President Obama the Fed's QE program will continue to be supported, which in turn will be supportive for Asian equity markets given increased global liquidity and a weaker US dollar.
Current Asian equity market forecasts are suggesting 12% earnings growth in 2013 – consistent with the long-term trend. Such an achievement is going to depend on global growth and regional policy decisions, and further policy stimulus will likely be needed, Swan suggests.
Policy will be important not only in the typical form of monetary/fiscal but also in terms of structural reform. Swan notes recent short and long term structural changes announced in India have seen the Indian equity market sharply re-rated. The hope now is for similar policy announcements soon from the new Chinese regime that will address short and long term economic issues.
BlackRock's head of Asia-Pacific fixed income, Joel Kim, believes the election result (Administration and Congress) is “the most politically difficult in terms of resolving the fiscal cliff”.
The IMF has forecast that a plunge over the cliff would affect a 2-4 percentage point reduction in US GDP growth. The US is currently expected to potentially only grow by around 2% in 2013, hence the IMF's numbers suggests a 'flat to recession' result. BlackRock is more sanguine, forecasting a 1-2ppt impact, suggesting a 'flat to low growth' result. It is suggested at least 3% growth is needed to meaningfully reduce the US unemployment rate, so a plunge over the cliff means the Fed – which is specifically focused on employment – will really have to fire up those printers.
Assuming a plunge, IMF simulations suggest a 25% relative impact for the China-Korea-Taiwan bloc. In other words, if US GDP growth loses two percentage points, those economies will see a GDP reduction of a net half a percentage point. The impact for India-Indonesia-Philippines will not be as great, but the impact for highly export-oriented Malaysia-Thailand-Singapore would be worse.
Kim expects the central banks of Korea, Thailand and Malaysia to respond with monetary policy easing. Kim also expects an unchanged Fed policy (low rates to 2015, open-ended QE) with Ben Bernanke staying on as Fed chairman.
John Boehner has suggested he wants to renegotiate the fiscal cliff under the concession of a fresh Obama mandate. He has also declared, nevertheless, that such negotiations will take longer than the “lame duck” Congressional period, meaning no result before the tax/spending Acts are triggered at year end. So what happens? No one knows. That's why the Dow was down 300 points last night.
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