Friday, 19 October 2012

Romney's First 100 Days

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The second presidential debate this past Tuesday was quite contentious and didn’t disappoint.  After President Obama got steamrolled in round one, he took a much more aggressive approach this time around and it seems to have paid off.  At the very least, he’s slowed the surge of momentum that Romney picked up since their first debate.

The national polls continue to portray a tight race, but Obama’s edge has grown slightly in the live betting markets as a 1.8 to 1 favorite.

What’s quite interesting is that, after two presidential debates and the sole VP debate last week, there has been no discussion of monetary policy.  And with the final debate focusing on foreign policy this upcoming Monday, we’ll still get nothing on this issue.

Both candidates have been avoiding any discussion on Fed policy like the plague lately.  You would think that, after the Fed just announced an unlimited bond buying program a month ago, it would come up somewhere in the debates.

As an investor, the aggressive actions taken by the Fed weigh heavily on our market sentiment and the decisions that we make allocating our capital.

And, of course, the outcome of next month’s election could have a profound effect on the future course of Fed policy and the financial markets.

It’s pretty easy to figure out what the ramifications of Fed policy would be if President Obama wins reelection.  Simply put, it will be business as usual.  Fed policy will continue its ultra-loose accommodative approach with full assurances of its abilities to conduct monetary policy as it sees fit by the Executive branch.

In fact, Fed Chairman Bernanke is poised to garner even more support when the FOMC voting members rotate, starting with the first meeting in 2013.  Richmond Fed President Jeffrey Lacker, who has been the only official dissenter of Fed policy action, is out.  And he’ll be replaced by one of Bernanke’s staunchest supporters, Chicago Fed President Charles Evans.

Also, the Fed’s two biggest policy hawks who have been publicly critical of the direction and efficacy of recent Fed policy actions won’t have an official vote either.  Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser won’t be voting members until 2014.

So an Obama victory will let Bernanke and the Fed continue to run monetary policy loose as a goose for the foreseeable future, and that should be bullish for risk assets, stocks and commodities, particularly gold.

But what if we get the other scenario and Romney wins?  How will this affect fed policy, and what will be the reaction from financial markets?

Well this is what we know.  Mitt Romney has made it very clear that he does not support Chairman Bernanke and the current course of monetary policy.  While the presidential debates have been reticent on discussing Fed policy, the Republican primaries were not and Romney was one of the candidates to strongly voice his opposition to its ongoing strategy to promote a stronger economic recovery.

He also made critical statements directly after the announcement that the Fed will begin an unlimited $40 billion per month bond buying program of mortgage backed debt.  The Fed’s balance sheet will likely top $3 trillion by the time Romney would take office.

Romney’s First 100 Days

The first 100 days after an inauguration is generally the benchmark period to measure the early success and effectiveness of a president -- especially in times of crisis.

When Obama first took office nearly four years ago, he quickly pushed for a massive stimulus spending bill -- The American Recovery and Reinvestment Act of 2009 -- that was quickly passed by the Democratically dominated Legislature.

Romney’s first order of business will likely be managing the state of the fiscal cliff.  How the Congressional landscape pans out will determine the urgency that Romney will have to deal with.

Let’s suppose that on Election Day the Republicans maintain control of the House of Representatives and pick up the net gain of four seats needed to retake control of the Senate -- a true political sweep.

With a Romney win and both legislative houses soon to be under Republican control, the likely scenario is that the lame duck Congress and outgoing President Obama would pass a bill to prevent the automatic triggers of the Budget Control Act of 2011 -- aka “the fiscal cliff” -- to take effect, essentially kicking the can down the road for the Romney administration and Congress to figure it out next year.

However, if the Democrats can hold the Senate it could get messy, and Romney may indeed need to act quickly if no definitive action is taken before year end and the tax cuts are left to expire and the sequestration of spending cuts kick in.  This would indeed be an ugly scenario and a low probability outcome.

But what about a “Monetary Cliff”?

Will the first invited visitor to the White House be Ben Bernanke?  Romney has already gone on record that he would replace the Federal Reserve Chairman.

Bernanke’s appointed term does not expire until January 2014 and, unless he willingly resigns, he cannot be so easily removed as stipulated by the Federal Reserve Act.  To remove the Fed Chairman (or any appointed Federal Reserve Governor) against his wishes would draw in a legal battle that would have to prove malfeasance or blatant wrongdoing.  And despite Romney’s disapproval, the Chairman cannot simply be removed for his policy opinions.

But with a Romney win and his outspoken displeasure with Bernanke Chairing the Fed, I would think that Bernanke would indeed offer his resignation and step aside, allowing Romney to appoint a new Chairman.  Besides, Bernanke would have less than a year left and would certainly not get reappointed anyhow.

With a dovish Fed Chairman removed, and a Romney replacement installed, would we now be facing a “monetary cliff”?

Will the stock market plunge if the FOMC takes away the highly dependent stimulus that it has been addicted to ever since the market bottomed in 2009?

Can the market hold key levels of support on its own, without the “Bernanke” Put that has cradled so many investors with a warm sense of security and perceived safety from sharp falling prices?

All of these questions will bring a renewed feeling of uncertainty to the markets with a Romney win, because all of the current pledges and forecasts that have been signaled and made transparent in the committee’s communications could soon be subject to an abrupt change.

“Are you telling me you won’t promise that interest rates will remain at ZERO for years anymore”?

If Romney does indeed bring in a new Fed Chairman and signal a shift in monetary policy, it will have to come very gradually so as not to spook the markets and send the stimulus addicts into a frenzied cardiac arrest.

It will also have to come with a counter stimulus measure from the fiscal side.  Perhaps, with dividend and capital gains rates presumably remaining low under a Romney administration, a tax holiday offered to corporations could be the perfect remedy.

Currently, US Corporations are sitting on $1.5 trillion in cash, and roughly 60% of it is overseas.

By allowing a one-time repatriation and dropping the 35% corporate tax rate on overseas profits substantially, that could allow billions in cash to funnel back onshore.  The funds could be used to distribute special dividend payouts to shareholders, initiate stock buyback programs boosting EPS, and encourage domestic spending and employment hiring.

If Romney wins and pulls the reins back on current Fed policy by appointing a hawkish replacement, he’ll likely have to fire a fiscal stimulus bullet to appease financial markets and won’t pile on more debt to the ballooning deficit.

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