Get ready for election fun

April 19, 2012

By James Saft

(Reuters) – If worrying about the impact of politics on your portfolio makes you want to scream, you probably ought to just turn off your TV and phone for the next seven months.

The 2012 U.S. presidential and congressional elections could set the tone for years to come on the single issue that may have the most power to move markets: deficits.

The United States has dug itself a deep fiscal hole, and that means some combination of spending cuts and tax increases to get out of it. More worryingly, perhaps, is a political atmosphere in which cross-party cooperation isn’t likely, increasing the chances of policy gridlock and bigger issues later.

Almost no matter how Washington plays it, the deficit will be a negative for financial markets. If it is allowed to grow, or even if investors decide there is not sufficient commitment to address it, U.S. interest rates could rise, hurting bonds and stocks. On the other hand, every dollar saved in government expenditure is one that will never find its way into corporate tills or household pockets.

A too rapid reduction of the deficit would hit the economy hard. On the other hand, rises in taxes will, obviously, have a similar effect on individual and corporate willingness to spend and invest. While individuals clearly have not been saving to prepare for higher taxes and fewer services in the future, it is one explanation for why corporations have been so slow to invest their cash hoards.

“The speed at which the U.S. fiscal deficit is reduced is key to the future behavior of the economy and financial markets. Success will be difficult,” Andrew Smithers, of Smithers & Co, wrote in a note to clients.

Don’t expect any real progress on addressing the deficit before the election. That doesn’t mean concern about the deficit, and how it impacts the economy if reduction is either too fast or too slow, won’t drive markets. It will, and it is likely to throw a scare into investors as election cycle rhetoric heats up.

For a funny, scary run-down on exactly where dysfunctional budget negotiations are now, read Stand Collender here:

(Editing by Walden Siew and Dan Grebler)

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