The most likely outcome of the 6 November elections is that not much is going to change in a relative sense. We foresee a second term for Obama, a (dark) red House of Representatives, and a Senate where the Democrats will win by a hair (although the latter is far from certain).
Whatever the results, subsequently President(-elect) Obama and a lame duck Congress (an official "change of guard" will not take place until the end of January) will have to pull out all the stops to stave off fiscal disaster at the end of the year. The Bush tax cuts are due to expire while military and social spending will be slashed, unless Congress intervenes. The tax cuts, a measure to boost the economy, have been rolled over since the Bush era. If the politicians fail to take action, everyone will have to pay more payroll tax.
The looming cutbacks have been devised because the parties could not agree on deficit reduction. The parties are under huge pressure to come up with a plan to get the public debt under control before the stroke of midnight on 31 December 2012. If they don't, the Democrats will be "punished" with deep cuts in areas such as social welfare while the Republicans will be hit with significant reductions in the defense budget.
We very much doubt whether Congress will present a clear-cut plan to eliminate the deficits before the year is out. There is too much animosity on both sides of the partisan divide. At the same time, neither party will be brave enough to dive headlong into the fiscal chasm (which could shave 3.5%-5.0% off economic growth). A compromise is more likely. If so, the tax cuts will largely remain in place whereas the buck for finding a structural solution for the mushrooming debt will be passed to the newly elected Congress. Probably, the incumbent Congress will unwind the sequester so the United States can "get by" for another while; until mid-2013 or slightly longer.
Such stopgap measures are unlikely to upset the markets. Especially as most have already been priced in. The downside is that the period of uncertainty will extend well into next year. The markets will probably become jittery whenever a deadline looms (as happened with the debt ceiling in the summer of 2011). In the meantime, Europe faces much larger immediate problems. The United States is lucky in the sense that it can continue the tried and tested strategy of "kicking the can down the road" for much longer than the eurozone. Yet sooner or later it will need to clean up its act. If not, the markets will resort to strong-arm tactics.
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