Alia iacta est! As networks projected an Obama victory, there was a
sea of red: the dollar is down versus currencies and gold. As pundits will
shift the focus on the fiscal cliff, the market appears firmly focused on
what may be more relevant: an Obama win favors a continuation of the current
easy money policy. Had Romney won, Fed Chair Bernanke would have become a
lame duck, undermining the credibility of the Fed's commitment to keep
interest rates low way beyond the end of Bernanke's term in early 2014. With
this uncertainty removed, the Fed's increased emphasis on employment is here
to stay. The market rewards this certainty by bidding up gold, selling off
the dollar versus all major currencies.
We don't believe the fiscal cliff is similarly
important: in our "worst-case" scenario, the "cliff" will
take place; however, once tax increases and spending cuts have taken effect,
Republicans may then agree to cut taxes, thereby keeping their promise not
vote for tax increases. While the drama may be worth watching, the market
impact may be limited. Note, though, the budget deficit would still exceed 3%
before factoring in an economic slowdown. Yet, we won't have come a step closer to entitlement reform. Entitlement
reform is unlikely to happen, as we believe the only language policy makers
listen to is that of the bond market.
Keep in mind, however, that testing the patience of
the bond market in the U.S. might be more dangerous than in the Eurozone: the
U.S., unlike the Eurozone, has a significant current account deficit. To a
significant extent, foreigners finance the deficit by buying U.S. bonds.
Should the bond market impose reform on policy makers in the U.S. by selling
off bonds, the implications for the U.S. dollar might be far more severe than
they have been for the euro.
As we all hope for the best, we would like to point
out to that hope is not a good policy, neither for politicians, nor for