A brief rally in European stocks on the back of President Barack Obama’s win in the US was halted by worries that the problem of the “fiscal cliff” is as big as ever and by bad German industrial production data later on Wednesday.
Results of the US election showed that the Democrats retained the Senate and the Republicans extended their majority in the House of Representatives, basically maintaining the status quo.
Reaching a compromise on avoiding a “fiscal cliff” – the expiry on December 31 of a series of tax cuts, the automatic reduction in spending due to last year’s compromise on the debt ceiling, as well as tax raises due to the coming into force of Obama’s health care law - “is not likely to get any easier” after the election, according to Bank of America Merrill Lynch analysts.
“The divisions between the Republican House and Democratic Senate remain,” they wrote in a market note. “This means that negotiations around the fiscal cliff will be challenging and uncertainty can linger in the business community.”
Volatility is likely to be high in global markets, just as it was more than a year ago during the impasse over the debt ceiling, which threatened to push the US into a technical default.
“There may well be a strong sense of déjà vu in the weeks ahead as US political leaders revive the arguments of summer 2011 over federal spending cuts and tax hikes,” Stephen Lewis, chief economist at Monument Securities, said.
“Already, Mr. [John] Boehner, the leader of the Republicans in the House, is claiming his party’s success in the House elections represents a popular mandate to resist tax increases as a means of reducing the federal budget deficit.”
Global emerging markets initially celebrated the Obama win, as they took it as “a strong signal that the weak dollar policy pursued by the US authorities is here to stay,” Benoit Anne, head of emerging markets strategy at Societe Generale, said. “Fair enough and they are right about that.”
But Anne added he was “not sure that the full-on, risk-on signal” was confirmed.
GO LONG ON...
The result is unlikely to influence the emerging economies in Central and Eastern Europe directly, Erik Berglof, chief economist at the European Bank for Reconstruction and Development, told journalists during the presentation of the bank’s annual transition report.
“I think the impact of the result is not so big,” Berglof added. “The big concern is what happens to the fiscal cliff in the US.”
Analysts said after the vote that the two issues – avoiding the fiscal cliff and raising the limit for federal debt – have to be settled “within weeks” to avoid triggering a painful recession which would impact the global economy.
For emerging markets, and European ones in particular, developments in Greece – where a new austerity plan needs to be agreed for the disbursement of more international aid – are also likely to weigh heavily.
“The next few days are set to be a little more exciting trading-wise than what we have seen over the past few weeks,” said Anne. In terms of trading in currencies, Anne likes the Polish zloty (PLN) and the Mexican peso (MXN), but warns that both of them face “major correction risks.”
The zloty “may yet again be victim of its own success” as it has been a popular emerging markets currency to be long of in Central Europe, because it is the most liquid in the region, while the Mexican peso is sensitive to moves in the S&P.
“No matter what happens, go long Asia FX, just pick a level you are comfortable with,” Anne said.
In fact, an upcoming change in leadership in China – where the Communist Party’s congress starts on Thursday – “is a more significant event for emerging economies than the reelection of President Obama,” said Mark Williams, chief Asia economist at Capital Economics.
“The installation of a cohesive Chinese leadership committed to putting the economy on a more sustainable footing would create opportunities for consumer goods producers while also signalling an end to the global commodity boom,” Williams said.
“The alternative is not more of the same but a further slowdown in China’s growth that would hit the emerging world much harder,” he added.