As we head into the final hours before the election, it’s worth taking a look at how potential outcomes might affect the fiscal cliff and the financial markets. A few thoughts:
To begin, Friday’s labor market report was not the game changer many thought it might be. Overall, it was generally a good report. Payrolls expanded by 171,000, well ahead of expectations and the best reading in months. In addition, the numbers for September were revised upward. On the downside, hourly earnings stagnated, wage growth continues to slow and the unemployment rate ticked up from 7.8% to 7.9%. All in all, a good report but one that is unlikely to have a significant impact on what is a proving to be a very tight race.
Just how tight? Most national polls have the two candidates in a dead heat. A bottom-up state-by-state analysis still suggests Obama is more likely to win, but that view largely rests on the assumption that the President can hold onto Ohio and Wisconsin. Beyond the White House, the House of Representatives is almost certain to remain in Republican hands, while the Senate appears headed towards something close to a 50-50 split. In other words, no party is likely to exit this election with a clear mandate.
Not having a mandate could matter a great deal when it comes to avoiding the fiscal cliff. From the perspective of financial markets, the most important issue near term is how the election will impact a possible fiscal cliff dive. If we see a Republican sweep – where Governor Romney wins and the Republicans recapture the Senate – the administration would be likely to retroactively rescind most of the expected tax hikes, removing a good part of the fiscal drag. If that happens, we could see a near-term “risk on” trade, particularly for US stocks.
However, under alternative scenarios – a narrow Obama victory or a Romney victory coupled with the Democrats keeping the Senate – the risks of going over the fiscal cliff go up. If either of those occur – and at this point there is a good chance they could — we’d expect a pickup in volatility going into the end of the year.