Policy Uncertainty Falls.

This afternoon's dramatic moves lower in equities and oil have been pinned on Romney trades being unwound, but we do get the feeling that there is a lot of Price is News and tail chasing going on when very little has actually changed. We will go into whether that is the problem or not below, but for now are happy to concur with our faithful reader "Leftback" when answering the question of this morning's post "Now What?"

"The answer appears to be "throw all the toys out of the pram" this morning, or as the Australians say "spit the dummy". Of course there is a limit to the profit available on that trade once your favourite plastic rattle and squeaky ducky is on the floor."  Indeed.

Historically the markets rally out of elections due to reduced uncertainty and we still believe that there is less uncertainty today than there was yesterday, but this post event dump is being blamed on Romney trade unwinds. It is surprising to TMM that so many had Romney win trades on but also for the following -  Although politicians and pundits like to claim otherwise, the evidence is that tinkering with tax policy (US tax rates wouldn't exactly be out of whack with other G20 countries) does not materially affect economic outcomes to any real degree. Of course Wall Street, eyeing up their own tax rates wanted Romney, seemingly blind to the fact that slashing spending and tightening monetary policy at an economically fragile time would plunge the country back into recession, and somewhat ironically, hitting their own wealth via falls in the value of their assets (particularly bank equities). Indeed there is no free lunch in "Diner USA"

Beyond the whiplash in the CTA and 5 minute macro crew, excitement on Bloomberg chats about "poor price action" and many trying to argue that "the status quo is the worst of all possible outcomes", TMM would actually point out that Obama and the Democrats have been handed a pretty strong mandate here, despite Boehner's spin early this morning. The electoral college was definitive, with most of the swing states going Obama's way, and gains were made in both the Senate and the House. Add to that, the fact that Tea Party candidates failed to gain any mandate whatsoever, the apparent split in the Republican party over strategy (and likely infighting over the coming months as a new position is decided upon for the midterms) and it becomes clear that the path to a solution to the fiscal cliff has become much cleaner: -

- The hurdle in the house for compromise is lower, so fewer moderate Republicans will need to be persuaded to pass a plan

- There are reports of Nancy Pelosi being replaced by a more moderate democrat as minority leader. This also narrows the gap that needs to be bridged.

 Whether measured by popular vote, electoral college, Senate or House, all either show a continued firm mandate for Obama and/or a swing toward the democratic position. It is thus exceptionally hard for Boehner et. al. to argue that they have a significant mandate for dramatic spending cuts and a rejection of any tax rises. Simply put, digging in their heels in the face of any compromise plan put on the table does not look like a credible strategy nor launch pad to the mid terms.

Finally, it is worth noting that President Clinton managed to get through his budgets after re-election, despite facing a Republican Senate and House. In yet another echo of the mid-90s, this came shortly after a government shutdown and debt ceiling debacle (cf Aug 2011)

Team Macro Man believe that the path to falling policy uncertainty began this week and the fiscal cliff may have to be downgraded to "road hump".