- Financial markets scale back on risk as the fiscal cliff is looming.
- Focus today on BoE and ECB meetings.
The Obama victory turned out be even more convincing than expected with Obama winning seven battleground states and also taking a clear lead in the "popular vote." However, the honeymoon days of Obama will not last long with the fiscal cliff looming. Yesterday Obama returned to Washington to start emergency talks with the Congress on this issue. Obama has been accused by Republicans of being deeply partisan but in his victory speech he promised to work with the Congress to reduce the deficit and reform the tax system.
Yesterday Republican House Speaker John Boehner said that the Republicans are ready to negotiate a budget deal and make changes to the tax code to raise new revenues. However, as the Wall Street Journal put it: "Whether this represents a temporary truce, or a step toward a pact to trim the deficit, won’t be known for weeks." The Washington Post is much less optimistic saying that Obama according to Democrats is "prepared to draw a firm line in the sand, even if it means letting one of the largest tax hikes in US history take effect on 1 January."
Financial markets certainly are not ready to give the benefit of the doubt to the US politicians. European markets initially cheered the re-election of Obama but when Wall Street came to work in the early afternoon the mood changed 180 degrees and both European and US indices ended the day with significant losses.
Dow Jones as well as S&P500 closed down 2.4%. The market has now started to price in the tail-risk of a political deadlock for the next two months and no solution to the fiscal cliff. We share the market concerns about the fiscal cliff and a further scaling back of risk seems to be in the cards the next couple of weeks.
As always, when risk-appetite is being scaled-back investors revert to the US dollar. EUR/USD is currently trading at 1.2750 after trading at 1.2876 yesterday morning. Despite the concerns US investors seek shelter in the liquidity of the US dollar. Considering that the market is not speculatively short EUR/USD to the same degree as was the case two months ago, further downside for EUR/USD is likely short-term, see our IMM update, 5 November 2012. US Treasurys also continue to perform with yields on the 10-year bond down close to 10bp.
Currently, all focus is on the fiscal cliff. Note though that Greek PM Samaras last night won parliamentary approval of the Greek austerity measures. However, in the current environment that will hardly be enough to support sentiment today.
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