US fiscal policy risk matrix - Rabobank

Philip Marey, Senior US Strategist at Rabobank, suggests that the US fiscal policy risks of the November elections depend not only on who becomes President, but also on the election results for the Senate and the House of Representatives.

Key Quotes

“Divided government will extend the status quo where the main risks lie in fiscal policy deadlines leading to government shutdowns and threats of a government default.

The risks from Republican control are tax cuts that push up the public debt trajectory, or heavy and abrupt spending cuts that could lead to a recession.

The risks from Democratic control are spending sprees that blow up the public debt, or tax hikes that could derail the economic recovery.

Divided government causes safe haven flows around fiscal policy deadlines, with downward pressure on rates, except for bonds that mature around the expected date of default.

Abrupt spending cuts (Republican control) or tax hikes (Democratic control) are likely to slow down the economy and have a negative impact on rates.

In contrast, spending sprees (Democratic control) or tax cuts (Republican control) that push up the debt trajectory could in the worst case scenario cause a US sovereign debt crisis with substantially higher government bond yields.”