The Hindu Business Line : US Presidential elections — Stakes high for financial markets

It is difficult to call the results this time also as the race is neck to neck. The results of the elections are of paramount importance to the future direction of economic polity of United States. This also explains why the world would be watching with rapt attention the elections' outcome.

What has made the stakes even higher for the financial markets is the sudden hike of official interest rates by China last Thursday.

Let us look at the likely impact of the elections to the course of financial markets.

One thing which stands out in the last four years of the current US Presidential administration is that it had to preside over an economic slump that robbed the economy of unprecedented numbers of jobs. The economy has been saved from going into a deflationary phase but the employment sector is as languid as before. The inflation numbers remain benign.

The US Federal Reserve is in the process of bringing the target overnight rate to a neutral level so that it would once again have some arsenal to fight any downward pressure. What makes the economic scenario messy is the burgeoning current account deficit. What ever may be the reasons — war, fight against terror and homeland security, the Clinton administrations' plans to make the US economy a surplus one in over a decade have been thrown out of the window.

The outlandish tax cuts have also hurt the balance sheet and the current account deficit is over $550 billion.

This administration has been using the policy of blessing the weakness in dollar, even though public pronouncements remain supportive of the strong greenback. This is one tool that the US Treasury has been using to run down the deficit.

The premise being that a weaker dollar would make imports expensive and exports competitive and help in shrinking the deficit.

Another clear eco-political agenda has been to force the transfer of some this burden to other countries.

Japan and Europe have not resented the appreciation in their currencies. The pressure had been mounted on China to allow its currency to appreciate.

If China were to allow widening of the band in which its currency moves, it would also have an immediate impact on the other Asian currencies. Such an appreciation would be akin to transferring the burden to the Asian countries.

China surprised all by hiking the benchmark rate by 27 basis points and also removed the cap on bank lending rates. The US Treasury was quick to assert that this was a move towards flexible exchange rates.

In case the Bush Administration comes back to power we would in all likelihood see a strong follow through of the above agenda. This would mean a weaker dollar across the board.

The move may turn to be sharper against the Asians than other currencies.

The Iraq imbroglio does not look like sorting out in the near future and Bush Administration may not have it easy.

This would continue to put pressure on the deficit. Crude oil prices have surged to unprecedented level but have moved a bit lower on expectations of slow down in China.

China had put in place quantitative restrictions a long time back to cool its economy. But that did not work. China may have to hike again shortly to bring the GDP growth down to 7 per cent from the current levels of above 9 per cent.

However, it would not be easy to slow down the Chinese economy as the world demand for cheaper goods continues to gallop.

In case there is a change of guard, the new Kerry Administration would reexamine the policy direction. This would mean that the dollar might not depreciate quickly. The new regime may win the support of some groups globally which have been hitherto marginalised.

The chances of exit from Iraq would be at least `perceived' to be better. This may cool off the prices of crude oil. Although the position on deficit is unlikely to change soon and this should send the new administration out in search of solutions.

It is certain that this week we would see some moves in the foreign exchange, equity and bond market which would be event led and would depend on the outcome of the US elections.

Its Bush-Kerry duel in the financial markets as well!

(The author is Senior Manager, Corporate Treasury Sales - Western India for HSBC. The views expressed herein are his own and not necessarily those of his employer.)

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