Careening toward the Fiscal Cliff

It seems you can’t read or hear the news nowadays without being bombarded about our impending doom about the US economy going over the fiscal cliff. Not to be left out, I thought I would also assail you with my two cents on the subject. The fiscal cliff refers to a combination of expiring tax cuts and across-the-board government spending cuts scheduled to become effective Dec. 31, 2012. The idea behind the fiscal cliff was that if the federal government allowed these two events to proceed as planned, they would have a detrimental effect on our already shaky economy, perhaps sending it back into an official recession as it cut household incomes, increased unemployment rates, and undermined consumer and investor confidence. At the same time, it was predicted that going over the fiscal cliff would significantly reduce the federal budget deficit. Washington is locked in gridlock with both political parties turning this into a blame game. My prediction is that the US may very well go over the “cliff”. At the very least, if a resolution is reached it will likely be an 11th hour compromise as both sides wait for the other to flinch. Both political parties have painted themselves into corners on this issue with most Republicans having signed Gover Norquist’s tax pledge to not raise taxes. Norquist has gone on record as saying his organization will pull support from any Republicans defying the pledge, which will leave that politician vulnerable in the next election cycle. On the other side, Obama campaigned (and won) on the notion of a balanced approached to decreasing the deficit (read raising taxes on the wealthy). Given the deadlock, it appears more and more likely we will go over cliff. However, I don’t think this will be the calamitous event many are depicting. This will cause the tax cuts and sequestration to go into effect. However, most of the tax and spending cuts won’t take effect immediately, but will happen over the year. I think both sides can then claim they didn’t cave. From there, I think both sides can then sit down and work backward on compromise. But who knows. While the equity and FX markets have remained jittery, they have essentially yawned at the daily ebb and flow of the fiscal cliff news cycle. The Nasdaq, S&P, and Dow are all almost exactly where they were at 3 months ago before this became a hot button issue. The same can be said for most currencies against the greenback.

In FX markets, the Euro had a run up over the past couple of weeks. This was mainly due to progress being made on the debt talks in Greece. After much wrangling, the Greeks finally got their next tranche of bailout funds. The Euro rose to around 1.3130 earlier in the week. However, it lost steam yesterday (Thursday) after the ECB held their rate decision. While their decision to keep rates on hold at 75 bps was largely predicted, their gloomy news conference afterward, reduced growth forecasts, and hints of more downside risks weren’t. The EUR/USD gave up about 130 pips after the call to fall well below 1.30. It is widely expected they will decrease rates at their next meeting in Q1, which should keep downward pressure on the pair. It has continued its downward trajectory today and is currently sitting around 1.2960.

The fall lower today was likely caused by the surprisingly good US jobs report data out today. Many investors were braced for bad news following Hurricane Sandy. Instead, the non-farm payrolls number increased 146k against expectations for around 50k. The headline unemployment rate also fell to 7.7%, its lowest level since December 2008. 2012 has had an average of 151k jobs/month added this year. Unfortunately, the US economy needs to average around 200-250k to make a material dent in the jobless situation. Nonetheless, it was a very good report.

The Pound’s trading chart looks very similar to the Euro as it usually does. The UK was hit with a number of bleak economic numbers out this week. The exchange rate is down about 80 pence this week from its high of 1.6130 on Tuesday. It’s currently trading around 1.6040.

Over the weekend, China will release its November data. Industrial production is expected to rise a bit along with fixed asset investment. Retail sales should be strong and inflation marginally higher. Nonetheless, these data releases can impact market sentiment because a China sneeze now affects global risk appetite. In addition to emerging market currencies, this release could have a particularly big impact on the Aussie and Kiwi currencies as most of their commodity exports go to China.

I apologize for the month-long radio silence. I recently had a fairly extensive knee surgery and was out of the office for awhile. For those of you that have ever had to spend any amount of time on crutches, I sympathize. I’ve already been giving a fair amount of thought to how I will “dispose” of the crutches once I am off of them. The use of explosives hasn’t been ruled out. Have a great weekend everyone!

For additional information please call (408) 556-8377.

Regards,

Brian Simonson
Senior Vice President - FX Trading

Bridge Bank, N.A.
55 Almaden Boulevard
San Jose, CA 95113
T. 408.556.8377
F. 408.275.0362
Email

Disclosure

Bridge Bank cannot accept liability for any inaccuracies that occur. No statement is to be considered as a recommendation or solicitation to buy or sell securities or other instruments or to provide investment, tax, or legal advice. Readers should be aware that the information provided is not intended to replace professional advice in relation to any topic discussed.

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