Focus on US – Markets focus on fiscal cliff, rather than US poll result

With the final outcome of the US presidential election still too close to call, markets are now focusing on the likelihood and impact of the so-called “fiscal cliff” where previously determined measures will impact both future spending and revenues by the government.

Markets have been as divided as voters in their support from the incumbent president of republican challenger Mitt Romney. Romney’s free market policies are attractive to many, but foreign policy gaffes and Romney’s remark that he would not offer US Federal reserve chairman Ben Bernanke a second term have fuelled uncertainty.

President Barack Obama represents continuity and stability, despite doubts over some of his domestic policies.

Kevin Gardiner, head of Investment Strategy EMEA, notes that historically, for markets, the wider economic backdrop has mattered even more than the occupant of the White House.

“The most pressing US political issue facing markets is the ability of Congress to reach cross-party compromise on the rapidly approaching ‘fiscal cliff’,” he says. “This is unlikely to be resolved as the general election results arrive in the small hours on Wednesday.”

He feels the US economic debate takes place in a much more liberal context than the European one, and that these differences are small alongside the wider economic uncertainties.

“Irrespective of the presidential result, the Congressional elections may return a Republican majority to the House of Representatives, but leave the Democrats with blocking power in the Senate (where only a third of seats are up for election).

“This likely divided Congress is what makes that looming fiscal tightening of more than 4% of GDP so dangerous,” Gardiner adds. “Its collective mood could be critically but unpredictably affected by the winners of key Senate and House seats, and by its interaction with the White House, and a quick resolution seems unlikely.

He thinks a compromise will be reached, and the actual hit to the economy in 2013 will be “a fraction of what it could be – a likely headwind, rather than a reversal – but only after some protracted brinkmanship extending up to and beyond the 1 January ‘deadline’.”

He advises investors “sit tight, but expect some resumed volatility into the New Year”.

“That could be another chance for long-term investors sheltering in ‘safe haven’ assets – especially government bonds, which are still fiercely expensive – to rotate into the assets we think offer the best risk-adjusted strategic returns, namely selected corporate securities (stocks and high-yield credit).”

He said the latest macro data – including today’s jobs report – suggest the US economy is approaching that fiscal cliff with a little more momentum than feared.

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