|V for Victory|
For the President then, it is back to business. For the Fed, Bernanke and, importantly for everyone else, it is business as usual. On fiscal policy, the key issue now is how the fiscal cliff is to be addressed, As discussed in Monday’s Market Tactics, the point is that Congress will not be able to strike the ‘grand bargain’ on fiscal consolidation. The preferred route is to skip the inevitable clash over differences in tax and spending policies and settle for a broad outline that will set the boundary to the negotiations between the Republicans and the Democrats when there is more time next year. That much is possible in the time left before the default position of mandated budget cuts becomes effective at the beginning of next year.
To introduce a bill that simply defers the fiscal cliff without some such framework risks leaving the corporate sector in the same world of uncertainty that is inhibiting growth and leaving monetary policy far less effective than it might be otherwise. Indeed, agreeing a broad budget framework consisting of goals with a time line for budget balance and debt sustainability might be the very antidote that re-invigorates the economy.
As for the ground that will require negotiation, it is an understatement to say this won’t be easy. The risk is that Congress will still get bogged down in the same old differences. Obama wants the Bush-era tax cuts extended except for those earning US$250,000 and he wants higher taxes for the wealthy but the Republicans won’t agree to this. Obama is happy to lower corporate taxes but the Republicans want to do so more aggressively. The Republicans also want to see estate taxes repealed but the President is against this. As for where the cuts in spending should fall, the Republicans in contrast to the Democrats seek major reform on entitlement programmes.
What can be expected for the markets? Everyone has made the point that since taking office, the US equity market has performed best among the major equity markets. This has been achieved by dedicated support for the economy from the Federal Reserve and, as The Economist recently noted, an Administration that has tackled various issues from saving the auto industry to a forced re-capitalisation of the banking system which, by all accounts, has left US banks in a position of strength that is the envy of their counterparts in Europe. This combined with corporate earnings that have continued to grow has helped to keep the underlying trend for the US equity market heading one way.
Uncertainty and volatility always reign but the pressure for bipartisanship is greater now than ever for Congress to compromise on a deal that avoids the fiscal cliff. A view I take, which may or may not be shared, is that if you don’t have faith in America, you can’t have faith in anything. My bet is that Congress will respond to the challenge, that there will not be a recession in 2013 and that the underlying trend for Wall Street will remain upwards.