A Romney victory could spook the US markets

With just over a week to go before the US election, it’s too close to call. President Obama is rediscovering his touch as a ladies’ man, polling well ahead among female voters just as he did when he won the White House back in 2008.

Republican challenger Mitt Romney, meanwhile, is the choice of most men – or at those who intend to vote. The outcome of this titanic struggle really is in the balance, not least in the likes of Ohio and Florida, the all-important “swing states”.

The normal assumption among financial analysts is that a Republican victory leads to a rally on America’s equity markets. Right-wingers tend to be fans of lower taxation, particularly on businesses, and less inclined to regulate.

Of course, though, the normal assumptions are far less likely to hold these days as we’re not living in normal times. Particularly in recent months, but for much of the last few years in fact, equity investors have been totally fixated not on underlying corporate performance measures, or even on whether or not Western economies have been doing well. What’s mattered above all, to the exclusion of almost everything else, has been the actions of central bankers.

Were Romney to win, paradoxically, the US stock market could tumble. That’s because the former Massachusetts governor would be most unlikely to extend the tenure of Democrat-appointee Ben Bernanke as Chairman of the Federal Reserve, when his current second term expires in January 2014. That political reality would then cast doubt on Bernanke’s recently-issued pledge that the Fed won’t raise interest rates until well into 2015.

Even more fundamentally, with the Republicans under pressure from sound-money Tea Party activists, and likely to remain so even if Romney wins, would a Republican-backed Fed Chairman really be so willing to extend Bernanke’s pledge to continue quantitative easing until the US economy is once again firing on all cylinders?

Since the summer, with the eurozone crisis far from over and the global economy on edge, Bernanke’s “open-ended” money-printing promise, as well as his mind-boggling ultra-long commitment to near-zero base rates, have helped US equities to defy gravity. The prospect of a hawkish Republican-appointee running the Fed, meaning less QE and possibly even inflation-fighting rate hikes, raises the kind of uncertainties that financial markets detest.

It should be remembered, also, that the likelihood of far fewer “special measures”, and an end to “super-easy” money, could also cause the dollar to rally. That, too, wouldn’t go down well with investors in US equities, given the extent to which a stronger currency undermines America’s competitiveness overseas. Together with the looming “fiscal cliff” – the possible repeal of Bush-era tax cuts in January 2013, which is likely to cause a huge row whoever wins this photo-finish Presidential race – investors on Wall Street are currently having a great deal of trouble getting their heads around what exactly is going on.

Already, doubts over the fiscal cliff, which some say could lead to spending cuts and tax rises equivalent to no less than 4pc of US GDP, are impacting capital spending. This was evident in last week’s GDP numbers, which showed the world’s largest economy expanding by just 2pc on an annualized basis during the third quarter, despite signs of life in the housing market and a big dollop of unsustainable pre-election defense spending.

As such, continued economic weakness means the Fed’s third round of quantitative easing, or QE3, will most definitely carry on if Obama wins this on-going electoral battle. But a Romney victory, funny as it seems, could mean all money-printing bets are off – and that includes quite a bit of the capital currently invested in the US stock market.

Ever since the International Monetary Fund Tokyo summit earlier this month, Bernanke has been on the defensive about QE. This is a reflection not only of domestic political shenanigans but also pressure from abroad. The large emerging markets are sick and tired of American “debasement” – which they rightly see as equivalent to an on-going “beggar-they-neighbour” competitive currency devaluation. Having leant hundreds of billions of dollars to the US, these rising powers also view QE as a “soft default” ruse, which whittles away the value of the American debts that they are owed.

Fed policy “helps strengthen the US economic recovery” Bernanke has claimed since Tokyo, and “by boosting US spending and growth it has the effect of helping support the global economy as well”. It is simply astounding that a Federal Reserve Chairman is now being forced to attempt to justify his policy profligacy to countries which, just a few years ago, held US policy-making in the highest-regard, as a model to which to aspire.

Just as US investors are obsessed by Bernanke’s actions, and the possibility of his political demise, eurozone financiers are fixated with the next move by the European Central Bank. In early December, Mario Draghi unveiled the bond-buying programme, which, despite its singular lack of detail, he had spent the entire summer selling to German Chancellor Angela Merkel.

As a result of this plan’s announcement, Spanish government bond yields have fallen, and talk of single currency meltdown, for now, has somewhat abated. Again, though, all this is based on assumptions – not least that the Spanish government will ultimately endure the humiliation of requesting a fully-blown bail-out, and all the conditions attached. The ECB would then require the nod from the Germans – as well as the Finns, Dutch and other nominally solvent but increasingly alarmed eurozone members – to commence with the mass joint-purchase of Madrid’s sovereign bonds.

While huge uncertainties over-shadowing the US and the eurozone, there are perhaps even bigger question marks looming over the UK. News that Britain managed to annualized growth of 1pc during the third quarter has driven a slew of triumphant headlines. It’s good that we are out of a prolonged double-dip recession, no questions, but now is when the fireworks could really start.

For just as America’s weaker-than-expected growth numbers last week make the continuation of QE more likely, so the UK’s stronger-than-forecast GDP data means our money-printing binge could end. This policy has been used, of course, particularly in Britain, to allow our central bank to buy up reams of our own government debt. Once QE has gone, or if financial markets think that the end is in sight, the assumed demand that has propped up the gilts market, keeping government borrowing costs low, is kicked away.

While speculation over the identity of America’s next central bank boss is growing, in the UK it is already in full swing. With Mervyn King due to step down next summer, the various contenders for his job seem to be laying out their claims for the job in terms of the extent to which they’d countenance more QE. One candidate, FSA Chairman Lord Turner, recently suggested “still more innovative and unconventional” monetary policies, perhaps including schemes such as cancelling the bonds the Bank holds in its vaults as a result of QE, equivalent to notorious “helicopter drop” policies under which central banks simply give newly-printed money directly to households.

Last week, King bit back, dismissing such ideas as “dangerous”. The Bank “must have the ability to reverse its policy – to sell gilts and withdraw money from the economy – when that becomes necessary,” the Governor insisted. “Otherwise, we run the risk of losing control over monetary conditions.”

I find it simply incredible that an incumbent Bank of England governor is reduced to spelling out such fundamental truths to one of the leading candidates for his job. To be sure, we are living in abnormal times.


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