By Gerard Lyons
The US election results not only see a return of President Obama for four more years but also the Republicans retaining Congress and the Democrats the Senate. Despite the uncertainty of the last few weeks, these are the very results the markets were expecting.
The result is a removal of the political uncertainty but markets still have to contend with a continuation of economic and policy uncertainty. Despite the euphoria of the election victory one should not forget how divided the Republicans and Democrats were during the campaign on some areas and thus one can expect some big policy differences during the next four years. But for now, immediate attention will be on the fiscal cliff.
There is a likelihood of a compromise being reached in this lame-duck session of Congress, before year-end. The uncertainty over fiscal policy has already had a negative impact on the economy as spending plans have not been rolled over in some areas of government, impacting business. The “cliff” itself, with automatic tax increases, or the ending of tax breaks, and spending programmes not being extended, among other things, could knock over 4% off US growth-hence the concern.
Although the economy is improving it is too fragile to cope with such a shock. The likelihood is a compromise, extending some combination of the tax and spending programmes. But it would still not be growth constructive but at least not as bad as the worst case, and it would remove the uncertainty, although as we have seen before, from now to year-end will likely see some nervousness as to whether things will be agreed in time.
But the US does not just face a fiscal cliff. As I have said before it has faced “a fiscal cliff, a regulatory mountain and a jobs depression”. In recent months the economy has shown progress on the jobs issue. Now there is a need for that to continue, and for progress on the other two areas as well: the fiscal cliff and the regulatory mountain. The latter has not always received enough attention. The balance sheets of US firms, particularly larger ones, have been improving. But they are reluctant to invest. The weakness of demand has been one reason. So too has been uncertainty over regulatory policy under President Obama.
Demand is improving but needs to withstand any fall-out from the fiscal cliff. Regulatory policy in the second term needs to be addressed; firms seem most concerned about the increasing cost of all the regulatory measures. Trouble is it is hard to quantify fully this effect. It may be that firms have exaggerated this, as a reason not to invest. But as demand recovers – albeit gradually – firms will find more reasons to spend too. And rising wages in China and cheap shale energy may help US competitiveness.
While all this continues, expect a continuation of Fed policy. It remains growth constructive. Monetary policy appears to be working better than before. Smaller firms now appear to find it easier, but still tough, to access funds. The housing market is showing signs of recovery. And indeed, in recent months, it is clear that the combination of the Fed’s monetary policy and President Obama’s fiscal policy has helped the economy. As we thought, the US is recovering. But managing expectations is key: this is a steady not a spectacular recovery. There is still an overhang of debt in parts of the economy and this still takes to work through.
In recent months the markets have been revising down their US growth forecasts. That is partly because the market was too optimistic before. But this may be the time to revise up US projections. Depending on what happens on policy in coming months, the steady but not spectacular recovery should continue in 2013 as growth edges up.
Although US political uncertainty is now easing, the world economy and financial markets still have to contend with concerns in other regions, namely China and Europe.
In recent months worries about the euro area have eased, but as the riots yesterday in Spain and Greece demonstrate, there are still deep problems as austerity measures continue to be implemented. While one should not underestimate the political commitment in Europe to keeping the euro project alive, one also cannot underestimate the economic and social pain being seen in the Periphery. I was on TV last night here in the UK discussing this with the Former Prime Minister of Ireland and as I was saying that this is not the economic time for the Periphery to be pushing through painful reforms he was saying that politically this is the only time that reforms can be pushed: when times are bad. Therein lies the problem. So expect more of the problems we have seen before, with bouts of uncertainty returning. But the good news is that the European Central Bank’s actions have put a floor underneath things, providing liquidity and pulling the euro back from the brink.
Also in recent months there are signs that the politicians across Europe are more prepared to reach out to Greece, which should provide some financial leeway, but not much. Despite all this, Greece is still in recession and there could yet be a further market shock.
While one should never take one’s eyes off Europe – particularly Greece in coming days given the austerity vote – immediate attention will also focus on Chinese politics and in particular on the new Politburo Standing Committee, which is widely expected to revert back from its current nine members to the more traditional seven.
The latest rumors from China are that a couple of the reformers who were expected to be on the Standing Committee will not make it, but no-one in the public really knows, and it tends to be that the same group of names, usually ten, are always mentioned. But even though we will know the seven names in a few days, the focus will then switch to policy. For some, the main focus is as to what will happen on political reform, but for the markets the issue will be on the direction and pace of economic reform.
China needs to continue with economic reform and I think it will – whether it is gradual or faster will become clear. To begin with, though, the likelihood is a continuation of current macro-economic policy measures. And these are consistent with a soft and not a hard landing for the economy now.
At least China’s new leadership will not have to contend with an immediate change in US foreign policy, and the uncertainty and change in focus that a Romney victory would have brought. In his first term, two of President Obama’s most important words were “and” and “pivot”. “And” was early on in his Presidency in the context of when he changed the strategic economic dialogue with China to a strategic “and” economic dialogue. Pivot was last autumn when he talked about the “pivot” in economic and military terms between the US and Asia. The future US-China relationship in this new political environment in both countries is centre-stage.
So, the US electoral uncertainty is over. Now we just have to focus on all the other uncertainties. And although vulnerable to shocks, at least the economies in China and the US appear in better shape than a few months ago. And perhaps that was a contributory factor to President Obama’s re-election last night.
The writer is the chief economist at Standard Chartered Bank Group.