Election Post-Mortem by Tim McLaughlin
President Obama was re-elected for a second term as President, with Democrats retaining the Senate and Republicans maintaining control of the House. Although this outcome returns the status quo, this has important implications for the economy and the markets. Specifically three issues: 1) Fiscal Cliff, 2) Fed Policy, and 3) Housing Policy.
Fiscal Cliff: Returning to status quo likely means all sides see the voters as supporting their views, which means reaching compromise is not likely to get any easier. Moreover, the divisions between the Republican House and Democratic Senate remain. This means that negotiations around the fiscal cliff will be challenging and uncertainty can linger in the business community. We see the risk that we temporarily fall over the cliff to be larger than it would be under a Romney victory. President Obama has called for tax increases for the upper income bracket, which the Republicans have resisted. If Republicans do not concede ground on this issue, then the risk rises that Democrats allow the Bush tax cuts to all expire in order to push their own “middle income tax relief” plan.
Fed Policy: Fed Chairman Ben Bernanke’s term is set to expire in Jan 2014. We believe President Obama would consider renewing his term. If Bernanke were to decline to stand again, we would expect current Fed policy to continue under a similarly sympathetic Fed Chair, such as Janet Yellen – who would be acting Fed chair anyway until a Bernanke replacement is confirmed. The FOMC voting members will be particularly dovish in 2013, and we expect the Fed to continue to buy $45B of Treasuries (outright) even after Operation Twist ends at year end.
Housing Policy: There is a chance that President Obama may chose to appoint a new acting director for the FHFA during the recess period. This would be an opportunity to replace Edward Demarco, who has been working to shrink the presence of the GSEs in the mortgage market, with someone who is more willing to put in place additional housing stimulus. The risk is that President Obama will see the appointment as counter-productive to negotiations around the cliff and will not want to take that risk. If Obama were to appoint a new FHFA chair, he or she would likely be more willing to accommodate additional housing stimulus. This could take the form of greater mortgage refinancing, slower increase in guarantee-fees and more aggressive modifications. However, there are limits to how much additional stimulus can be put in place given the mandate of the FHFA to minimize taxpayer losses while the GSEs are in conservatorship.
The focus will clearly be on the lame duck Congress the next 10 weeks and what can be done to avoid the fiscal cliff and manage the debt ceiling short term.
