US Steps Back From Fiscal Brink…

16th October 2013

“We can’t allow 30 or 40 people to hijack the Republican Party.” Republican Congressman Peter King, speaking this week

The Tea Party zealots have been belatedly reined in by the Republican establishment (forced into compromise by collapsing poll numbers and furious corporate donors); for a party that wraps itself shamelessly in the flag, threatening to allow military pay checks to bounce at the end of the month was always political suicide. While the bipartisan committee tasked by December to agree a long-term budget deal will have its work cut out, investors can now refocus on pretty decent near-term fundamentals, despite a backdrop of longer-term structural risks from ever rising US income inequality to slowing EM trend growth. Having seen net speculative positioning move short on the debt ceiling brinkmanship, the USD index now looks very cheap, back to its five year average despite the improving current account trend, 2% plus growth and Fed tapering by Q1, and could well rally over 20% to test the 100 level in 2014.With energy imports having accounted for over 50% of the current account deficit over the past decade, the shale output boom (allied to on-going efficiency gains from hybrid cars, LED lights etc.) will be a structural dollar tailwind through end-decade, particularly as the fiscal deficit is on track to fall sub 2% of GDP in FY 2015.

The polarization of politics in Washington is fuelled by unprecedented income inequality and the fraying of the ‘American Dream’, to which neither party has a coherent response.  While the steadily rising profit/falling labour share of GDP is a pattern evident globally, it is proving particularly traumatic for the US.  Real median household incomes have fallen in each of the last five years (a similar pattern is evident in many other developed economies like the UK) and have barely grown over the last couple of decades. The sustained QE program has contributed to increasing economic inequality by enforced negative real interest rates on holders of cash, while boosting prices of riskier financial assets, more commonly held by the top decile of earners.

The market capitalization of the Wilshire 5000 is up $11.4trn, or 166%, to a record $18.5trn since March 9, 2009 while the median existing single-family home price is up over 37% through August since it bottomed during January 2012 and is now just 8% below its record (nominal) high during July 2006. With earnings growing at just 2% y/y, one source of relief for discretionary spending power may come from US gasoline prices as the EPA adjusts federal ethanol mandates (the 2005 Clean Air Act), which have artificially boosted prices by forcing refiners to buy ethanol credits as gasoline demand has fallen to decade lows due to lower average mileage and a more efficient car fleet.  A gasoline price falling back toward $3 a gallon would be a very useful windfall in coming months, after the hit to consumer confidence from the idiocy in Washington.