The Election & Aftermath: Investment And Economic Predictions Plus Strategies From Jefferies And Co.
The Election & Aftermath
We will know by this time tomorrow most of the election results. The worst case scenario for all of us would be an election that is so close in some of the sawing states that the election gets turned over to a host of attorneys. As a nation, we do not need that again as it would only increase the severity of the fissures in an already divided nation. Furthermore, neither Barack Obama nor Mitt Romney will look good with a Grizzly Adams beard and an extra fifty pounds.
Here is our take on the layout of the land.
For reference, heading into the election, fed funds futures were trading 16 bps out through 2013, trading 27.5 bps for December 2014 and 49.5 bps for September 2015. Sep 2015 fed funds futures have effectively traded with the polls, averaging 24.7 bps in late October before dipping to 20 bps in the aftermath of the Obama â€œSandy bump.â€
If Barrack Obama Reelected:
The Fed & Monetary policy:
There will be no immediate effect on monetary policy.
If the second Obama administration is as ambivalent toward business and economic growth as the first administration was , then the Fed is likely to meet and could exceed current expectations for remaining extraordinarily accommodative well into 2015. While it is not clear that Ben Bernanke will step down after his term as Chairman expires in early 2014, scuttlebutt out of the Fed and the Princeton campus is that the Chairman is expected to return to academia upon the expiration of his term. If Bernanke wants to be reappointed, President Obama would probably reappoint the Chairman to another term. Janet Yellen would be the likely and logical choice to be Bernankeâ€™s successor were Bernanke to decide to leave.
In either case, it would be reasonable to expect both the rate and balance sheet policy to remain extremely accommodative well into the distant future. Bernanke and Yellen appear to be closely aligned on policy. We doubt it is a coincidence that Yellenâ€™s proposal for an â€œoptimal control modelâ€ approach to the implementation of monetary policy is remarkably similar to the current implementation of monetary policy and the FOMC policy expectation â€œthat a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthensâ€œ
Be it Bernanke or Yellen at the helm, the combination of either as Fed Chair and a continued ambivalence toward business will restrain the recovery and bode for a continuation of the Fedâ€™s extraordinary rate and balance sheet policies far into the future.
The Treasury & Fiscal Policy:
With Treasury secretary Geithner departing the Treasury Department for parts unknown, President Obama will need to appoint another Treasury secretary. Names that are being bandied about include Washington insiders and outsiders.
The insiderâ€™s list includes Gary Gensler who is currently the Chair of the Commodity Futures Commission and former Treasury undersecretary for domestic finance. Gensler was also a senior economic advisor to President Obama during the 2008 election campaign, so he also has the right political connections.
Another name making the rounds is Gene Sperling, who served as director of the National Economic Council (NEC) under President Clinton and was involved in both the 1993 Deficit reduction Act and the 1997 Balanced Budget Acts. Both these experiences could serve him well in this era of fiscal ineptitude. However, Sperling is probably a long shot because he was also involved in the Financial Modernization Act of 1999, AKA Gramm-Leach-Bliley, which repealed much of the old Glass-Steagall legislation. President Obama has been reported to believe that Gramm- Leach-Bliley was a significant contributor to the subprime mortgage fiasco and financial crisis that ensued, so that weighs against Sperling.
Also on the insider list is administrationâ€™s Budget Director “Jack” Lew. Lew has been involved in the debt ceiling and deficit reduction negotiations in recent years. So Lew does have valuable experience with debt ceiling and budget negotiations, but it would be a stretch to say that has been successful, however.
A more intriguing name that has cropped recently is BlackRock CEO Larry Fink. An appointment of Larry Fink would represent a significant shift for the Obama administration and might be an effort to extend an olive branch to the private sector. Regardless of whomever is selected as the next Treasury Secretary, the US will continue to publicly advocate a â€œstrong dollar policyâ€ as every administration â€“democratic or republican– has done for decade, but also doing little or nothing to attain this objective.
If Mitt Romney is elected: The Fed & Monetary policy:
There will be no immediate effect on monetary policy. Mitt Romney has been openly critical of Bern Bernanke, but Ben Bernanke will finish out his term as Fed Chair.
If Bernanke wants to be reappointed, it is highly unlikely that Mitt Romney will reappoint the Chairman to another term. It is not inconceivable, however. Keep in mind that a President Romney will want to be reelected and, therefore, want to have a Fed Chair who gives job creation a high priority. It is less likely, however, that Bernanke would want a second term as Fed Chairman were Mitt Romney the President. It is also highly unlikely that Romney would appoint Janet Yellen as a Bernanke successor.
For a Bernanke successor, Romney would probably choose from his array of economic advisors, Glenn Hubbard of Columbia University, Greg Mankiw if Harvard University, John Taylor of Stanford University and Kevin Hassett of the American Enterprise Institute. Hubbard has been reported to prefer the job of Treasury secretary to Fed Chairman, so he probably would remove himself from contention.
Hassett has been an economic advisor to John McCain and George W. Bush. However, Hassett is primarily known for his work on tax policy, which would also make him a more likely candidate for a job at the Treasury Department, or perhaps as chairman of the Council of Economic Advisors.
John Taylor, of â€œTaylor Ruleâ€ fame, has been very critical of Fed policy over the past several years, asserting, among other things, that the â€œmonetary excessâ€ of the Fed were at least partially responsible for the US housing bubble and consequential financial crisis. He also was critical of QE and an advocate of more stable monetary policy that focusses on the long run implications of monetary policy rather than the short-run. Taylor is the candidate who would be most likely to propose the biggest changes from the policy approach being implemented by the Fed at the current juncture.
Mankiw is also a former NEC director and is also the least hawkish of the possible Romney nominees. For example, Mankiw has been sympathetic with the view that the FOMC should allow inflation to run above target to spur growth and proposed a â€œlevelâ€ inflation target which would allow the Fed to overshoot the inflation target if it undershot the inflation target in the prior year.
We have no idea if either would want the job, but we think that the final choice will be between Taylor and Mankiw, so the implications for policy would be quite different. Were Mankiw to be appointed as Bernankeâ€™s successor, it would make for a much more gradual and moderate transition from the Bernanke FOMC than Taylor, and it would also be more compatible with a President Romney wanting a pro-jobs Fed Chairman with an eye on his reelection.
The Treasury & Fiscal Policy:
We think that the choice would come down to Hubbard or Hassett for Treasury Secretary, with Hubbard being the selection. If this is the case, then it is highly unlikely, in our opinion, that the Treasury Department will play an activist role in stimulating the economy beyond lowering taxes. Consider the following quote by Hubbard that criticizes some of President Obamaâ€™s economic policies and also sums up his views on the role of government and taxes:
â€œThe fundamental choice about government is how big it is… If we actually wanted the government the president (President Obama) has proposed, you would have to raise taxes to pay for it.â€
Hubbard is also an advocate of consistent tax and regulatory policy that reduces uncertainty in the business community. So, Hubbard is an advocate of an efficient and competitive tax code and a sustainable trajectory of federal debt, and disdainful of short-term â€œfixesâ€ Regardless of Romneyâ€™s choice of Treasury secretary, the US will continue to publicly advocate a â€œstrong dollar policy.â€ Were Hubbard to be the next Treasury secretary, the Treasury department might actually implement a policy that is consistent with that stated objective.
The Senate & House:
Regardless of who is elected president, the president for the next four years will likely have a Senate that is narrowly controlled â€“probably by the democrats– and a House that is controlled by the republicans, with a strong Tea Party block. Therefore, if anything is to be accomplished on the fiscal front, the art of compromise will have to be resurrected in Washington and bipartisanism will have to make a comeback.
Were President Obama to be reelected, he will have strong incentive to find a way to reach his â€œGrand Bargainâ€ on the deficit. He will already go in the history books for being the presiding president when the US received a credit downgrade, and he will not want to be the presiding president for a second downgrade, which is a legitimate threat if significant fiscal progress has not been attained by mid-2013. He will not want credit downgrades to be his presidential â€œlegacy.â€
Were Governor Romney to be elected, he will have the benefit of a â€œhoneymoonâ€ period and also an eloquent advocate for tax reform with Vice President Paul Ryan.
Fiscal Cliff is symptom of fiscal ineptitude, time is running out to get it right.
The fiscal cliff will become the immediate obsession after the election, but the expression connotes an abruptness that does not capture the nature of the fiscal problems. Rather, the US is in for a long period of fiscal water torture as the politicians grapple with fiscal issues. The fiscal cliff will be the first issue during the lame duck session, but the budget and debt ceiling will figure prominently throughout the 2013 political scene. (We will address this in a future commentary.) Whoever is president, he will have to act quickly to avoid another downgrade.
The key point is that time is running out for addressing the US fiscal folly before it permanently eradicates the prospects for prosperity for future generations that are awash in debt and social liabilities.
The costs are piling up on the younger generation. Total public debt outstanding is in excess of $16 trln. Student loans outstanding are in excess of $1 trln, an average of about $27k per student. According to the Social Security Administration, â€œthe annual cost of Social Security benefits expressed as a share of workersâ€™ taxable earnings will grow rapidly from 11.3 percent in 2007, the last pre-recession year, to roughly 17.4 percent in 2035.â€
The Affordable Care Act will force young and healthy people, most of whom do not tend to need a lot of health care, to buy health coverage costing several thousands of dollars to subsidize the insurance premiums of those who tend to utilize health care services more extensively such as the baby boomer generation that will also be receiving Social Security benefits. These are two very hefty intergenerational income transfers.
There is only so much the younger generation can bear and still be able to pursue life, liberty and the pursuit of happiness and a prosperous future.
Get out and vote, folks. It matters a lot.