Thursday, September 26, 2013

From the election in Germany to US fiscal angst

Now that the first tapering “stop-go” decision and the German election are out of the way, attention has turned swiftly to the upcoming fiscal deadlines in America.

In Germany the focus is now on coalition negotiations.  As was widely expected, Merkel’s CDU/CSU party took the greatest share of the vote.  The only question was whether the current coalition partner FDP would make it past the 5% threshold for seats in the Bundestag.  In the end it failed meaning the most likely scenario now is the so-called “grand coalition” between CDU/CSU and their former coalition partner and currently second biggest partner in the Bundestag, the centre-left SDP. 

Negotiations are likely to take some time.  SDP will be anxious to avoid a scenario whereby their support-base fades away as the junior partner of a coalition.  They will want some major “wins” in coalition talks to appease their support base.  And don’t be surprised if there is also talk at some point of a SDP / Greens coalition with the remnants of the east German communist party, Die Linke (The Left).

Markets have taken the election in their stride.  As we said at last week’s Portfolio Watch webinar, all of the major parties have similar views on Europe meaning there was little implications in the way forward for the Euro zone in this election  (although the German Constitutional Court may still through a curve-ball in that direction). Policy differences were mostly contained to domestic issues.   Also there was no risk of the sort of public backlash against the political establishment we have seen in the likes of Italy with the rise of the Five Star movement.  The only anti-euro (officially “euro-sceptic”) party was the new AfD party which also failed to get to the 5% threshold, although did well to achieve 4.7% of the vote at their first election and could be expected to build on their support base in the years ahead.

In the meantime, attention is now firmly focussed on fiscal negotiations in the US....again.  In the absence of a bi-partisan medium-term fiscal strategy (which we expect to be the next thing on the agenda after Hell freezes-over) or a political scenario in which the President also has majorities in both houses of Congress, fiscal angst is just something we will have to get used to.  In the lead up to the US election last year remember our wish was simply for a President with a strong mandate regardless of party affiliation.  Foiled again....

Where are we right now?  A new Budget needs to be agreed for the 2014 fiscal year by the end of the month.  A Continuing Resolution has been passed in the House and a vote is expected in the Senate shortly where it will most likely fail.  The Republicans are attempting to tie their support for a new Budget to the defunding of “Obamacare”.  This is the major sticking point, even though the President will argue he won a fresh mandate only last year including his healthcare plan.  There is only so far the Republicans can push things.  Then there is the debt ceiling which needs to be raised by the end of October.

It’s important to note that the current negotiations are taking place at a time when we are seeing a sharp turn-around in the government’s fiscal position.  That’s of course largely thanks to the tax increases that were effective from the start of this year and the more recent sequester.  Revenues are higher (up 12.8% in the year to June) and expenditure is lower (down 3.9% in the year to June).  The deficit is now 4.3% of GDP, significantly better than the peak deficit of 10.1% of GDP at the start of 2010.

Over the next few days and weeks we expect considerable fiscal sabre-rattling.  But as we have for every fiscal negotiation so far, we expect an 11th hour resolution.  In the meantime, if you start to get worried, just remember this is politics.  No-one wins from a shut-down of the US Government, least of all the Republicans.