The Impending Fiscal Cliff
The political season – always a source of amusement and certainly a catalyst of volatility – has been largely ignored by the market thus far. Perhaps once a Republican candidate emerges from the primary wasteland, the market will begin to fully appreciate the ramifications of the election season this Fall.
Although presidential elections can always create their fair share of uncertainty in the marketplace, this election season promises to offer much more in terms of volatility given the amount of fiscal uncertainty going into 2013.
Remember our duly elected leaders passed on making important decisions last year and, as a result, numerous and potentially economically altering policies will (at least in theory) go into effect when the clock strikes midnight on New Years Eve! For starters, there is the $1.5 trillion in forced spending cuts that came out of the failed bipartisan committee after the debt ceiling debate this summer. On top of that, you have both the payroll and the Bush tax cuts expiring at the end of the year.
Although a few of our elected officials have voiced concern over the impending economic calamity, the reality is until the presidential election is complete and one party comes out with a “mandate” it is highly unlikely any of the aforementioned issues will be addressed beforehand.
Thus, the folks in D.C. will have a little over a month and a half to hammer out more realistic spending cuts and overhaul our current tax code – not a bet I would want to be long come the Fall in light of their recent performance on these issues.
The Treasury Market Has Stabilized…For Now
The rapid ascent of Treasury yields that we witnessed several weeks back has been halted (for now) – and we are about 20 bps off the high in ten-year Treasury yields. The macro risks that I highlighted previously combined with Mr. Bernanke’s “dovish” testimony to Congress and the ever present QE3 chatter has led Treasury yields back down. That being said when one looks at the actual economic fundamentals (and the equity markets march upward), one could conclude that the Treasury market will be in for a nasty surprise once it is clear the Fed juice it out of the market.
In fact, a digression into the actual economic fundamentals paints a much more robust picture in the current economy than last summer when ten year Treasury yields were hovering between 3% and 3.25%!
Once the Fed is out of the marketplace it could get ugly, and as we were recently reminded the sell-off in the Treasury market will not be linear in nature.
