The Morning After

Obama has been reelected, the Senate remains in the hands of the democrats, while Congress is controlled by the GOP. Most importantly, the printer is firmly in the hands of Ben Bernanke. In other words, nothing has changed, as was largely expected all along. The worst case scenario - a protracted litigation, challenging the results of the election - has been avoided after Mitt Romney contested shortly before midnight, and as a result the immediate downward gap in risk following the election has been largely recouped overnight. More importantly, '4 more years' of the same monetary policy and no end to currency dilution have resulted in a nearly $50 jump in gold overnight with the metal in the $1720s this morning, because while the Fiscal Cliff remains hopelessly unresolved, and the baseline scenario that the market will need to tumble to shock politicians into waking up, remains (as does Goldman's 1250 year end S&P price target), the reality is that no matter what happens, Bernanke and crew will print and monetize the coming deluge of debt (which would also have been the case if Romney had won). And with total debt set to rise to $22+ trillion over the next 4 years, a deluge it will be. Most importantly, with Obama reelected, Europe is now "off the hook" and can finally rock the boat, which means Greece can take its rightful place at the front of the domino chain. Remember: the latest Greek austerity vote is today and voting (i.e. debating) has begun, and with vote results expected later today. It also means that the military festivities in the middle east, where the US now has 2 aircraft carriers and 2 marine assault groups, can resume.

A just released Op-Ed by Pimco's El-Erian touches on all the key points:

Now, the morning after an expensive and acrimonious campaign, a re-elected President Obama must find a way to get Congress to step up to its responsibilities on economic governance. The election did nothing to heal the seemingly intractable partisan divisions in Washington. In fact, the bitter tone of the presidential contest could well encourage further polarisation.


Continued Republican control of the House and a filibuster-prone Senate suggest that President Obama will need to aggressively follow through on his economic vision while naming and shaming Congressional disruptors even more. This could do more than strategically align citizens’ desire for clear economic direction with their low opinion of Congress’s effectiveness; it could also influence the behaviour of new members coming into Congress (and there are quite a few of them).


While markets wait for this to happen, and unfortunately it could take quite a while, bond and equity investors could well experience a series of “Groundhog Days” – finding that a hyperactive Fed (still struggling to compensate for the paralysis of other policymaking entities) remains their best friend; and that the fiscal cliff, Europe’s debt crisis and Middle Eastern geopolitical risks continue to constitute threats to the asset classes’ favourable correlations and low volatility.


Have no doubt: yes, an enormous sum of money was spent on the campaigns; and, yes, many promises were made as the candidates sought to differentiate themselves. Yet, after an initial flurry, it is essentially déjà vu for investors. They will continue to hope for political sputnik moments while worrying about potential market instability.

Some more immediate thoughts, with an FX bias, from SocGen:

Can we expect a risk-on mood following Obama's re-election? In the very short term, that may indeed be the case: his victory means a loose monetary policy and weak USD policy will underpin economic activity in 2013. It implies low US swap rates and US bond markets outperforming the eurozone. However, we remain cautious as we see the initial market reaction as quite muted.


From a FX standpoint, we would see a lower USD/JPY via the interest rate channel (200dma at 79.62) and a higher AUD/USD (risk-on mood and hopefully more reassuring Chinese data, the 28 Sep high at 1.0474 or even the 21 Sep high of 1.0519 may be in sight). The profile for the EUR/USD is not as clear as eurozone drivers remain centre stage. Greece, Spain and, to a lesser extent, Cyprus and Slovenia are still potential sources of stress.


Cautious medium-term outlook. We do not think the initial market reaction constitutes a lasting trend. The US still must address the fiscal cliff over the coming weeks, with what will probably be a divided Congress. That is where the challenge lies. The US administration will have to renew more than half of the existing fiscal measures to avoid a marked slowdown in activity. This will have to go hand in hand with the first (smooth) signs of efforts in terms of fiscal discipline to satisfy rating agencies. Will it be enough to keep markets calm?


Risk factor. In the second scenario, were US structurals to come to the fore and take a turn for the worse, the USD and US bond markets would be in good position for a huge sell-off, with the debt ceiling and rating agencies on the radar, and 2008 still fresh in mind. This is a just risk factor for now. 10Y US swap rates have lost 200bp. The EUR/USD hit 1.60, with a completely different eurozone story. Should such a scenario occur, the cross would have to revisit 1.35 (2011 highs), before contemplating 1.4950 (2011 highs).

And as usual, the comprehensive market recap, via DB's Jim Reid:

Asian markets are retracing earlier losses with major equity benchmarks now off their intraday lows. The Nikkei, Hang Seng, KOSPI were all down somewhere between three and four-tenths of a percent earlier but are now mostly unchanged on the day. The S&P 500 Futures are also off the lows but still 6pts down since the US close. Gold continues to edge higher, up nearly $9 in the overnight session to $1725/oz as the Dollar index continues to weaken. Treasuries are also trimming back some earlier gains although the 10yr yield is still down 6bps at around a 3-week low of 1.688% as we type.

Clearly this is a developing story but the win for Obama likely ensures that money printing is here to stay which is market friendly. It’s still far too early to suggest what it means for the fiscal cliff though. Only time will tell on this front as it depends on how co-operative the Republicans feel after a defeat. This story will now slowly start to unfold.

As we conclude the key vote in the US, another vote to watch today will be in Greece as the Parliament decides on the austerity measures that are prerequisites for the next tranche of the bailout. According to Der Spiegel a narrow victory looks likely at this stage which would see the coalition government secure just enough votes (154) to pass it through the 300 seat parliament. Meanwhile a 48-hour planned protest that started yesterday saw 16,000 Greeks reportedly take to the streets in Athens. Apparently numbers were slightly disappointing which was blamed on public transport workers being on strike!! The Greek tensions have been overshadowed by events in the US but it remains a live issue.

Staying in Europe, markets yesterday perhaps got their first explicit signal from Rajoy with regards to the bailout prospects. The Spanish PM told us that it makes no sense to ask for a rescue if Spanish spreads stay the same. He also added that he’d want to know how much yields would fall with a rescue. Interestingly these headlines fail to provoke much weakness with the 10-year Spanish bond yields finishing the day 9bps lower at 5.66% despite a brief post-headline spike. The market doesn’t appear to be overly concerned on the timing of a Spanish aid request as long as the conditional backstop from ECB remains in place. This standoff can't last forever though and at some point the market will likely lose patience. This however doesn't seem to be imminent.

Beyond Spanish bonds and despite an uninspiring day for Euroland data, yesterday was overall a positive day for risky assets. Equity markets rallied on both sides of the Atlantic with the CAC, DAX and the S&P 500 finishing +0.87%, +0.70% and +0.79% respectively. US equities performance was helped by strength in cyclical sectors such as Energy (+1.57%), Financials (+1.21%) and Industrials (+1.10%). Commodities enjoyed a late surge into the final hours of US trading with Gold and Brent rallying +1.8% and +3.1% to $1716/oz and $111/bbl respectively. This was perhaps prompted by hopes of a President Obama victory and another term for Chairman Bernanke or at least someone in his mould.

Taking a slightly closer look at the data flow the final euro-area October services PMI fell slightly on the month driven by Germany’s headline PMI and a worse-than-expected reading for France. The good news is perhaps a better peripheral reading as Italian and Spanish services PMI edged higher in October to offset a weaker manufacturing sector. That said our economists noted that assuming no change for the rest of Q4 the October composite PMI would point to a GDP contraction of 0.5% qoq in Q4, below the -0.2% qoq that they are forecasting.

Looking at the day ahead, industrial output in Spain and Germany will be the main releases in Europe. The EU will also release its autumn economic forecasts later this morning while we might also hear from Draghi as he speaks at an event in Frankfurt at around midday. Merkel will also address the European Parliament this afternoon at 3.15pm London time before meeting PM Cameron at 10 Downing Street for a dinner later this evening. The key event though will likely be Greece’s parliamentary vote (likely to take place later tonight). It will be a quiet day as far as US data flow is concerned with US consumer credit and mortgage applications the only ones due. The Treasury will sell $24bn in 10-year notes though. In terms of earnings, BNP Paribas and Telefonica are some of the interesting names reporting. As for the US election, there will be a sigh of relief that uncertainty is out of the way and that the Fed are unlikely to have their wings clipped. However how long will it be before the market starts to price in the fiscal cliff scenarios?