The three questions bond investors are asking about the US election

"The polling is very close," says Michael Pond, a bond strategist in New York at Barclays. "We're all hoping we come in on Wednesday and have a definitive answer on who the president is."

As Obama and Romney make a final, frantic push for votes over the next 48 hours, bond and foreign-exchange markets are nervously watching. Photo: AP

By Richard Blackden

Bond and foreign-exchange traders love to place bets before big events and few loom larger on the calendar than a US presidential election.

The competitiveness of this race - national opinion polls still havePresident Barack Obama and Republican challenger Mitt Romney in a dead heat - has made that tougher than usual.

The 2012 race does not have the terrifying backdrop of a banking crisis that the 2008 contest did. However, the outcome arguably carries more importance for the dollar and US government bonds - a currency and a financial asset that remain at the heart of the world's financial system - than last time around.

As Obama and Romney make a final, frantic push for votes over the next 48 hours, bond and foreign-exchange markets are nervously watching three things.

The most pressing is the way in which Tuesday's result in both the presidential and Congressional polls determines how the US confronts the 'fiscal cliff' the economy is facing. It is the alarming nickname for $607bn (417bn pounds) of spending cuts and tax rises that are due to take effect in early January.

The Congressional Budget Office, a respected independent forecaster in the US, believes that if politicians fail to reach a compromise that either delays or reverses some of the measures then the world's largest economy will be forced back into recession.

With the UK economy barely growing and most of Europe in a downturn, it is a prospect that would likely see investors race for the perceived safety of US government bonds.

A Romney victory alongside the Republicans keeping control of the House of Representatives - and possibly capturing the Senate - is seen by most in the markets as the surest way of avoiding the worst of what the fiscal cliff threatens. The spending cuts would stay but the tax rises would not.

By contrast, the re-election of Obama with Republicans controlling Congress is perceived as the combination with the highest chance of failing to reach a deal that skirts the cliff. Although each sides blame the other, it was the same combination that took the US to the brink of default last summer during the debt ceiling negotiations.

If the fiscal cliff is the most urgent concern, what the election could mean for the direction of interest rates in the world's biggest economy over the next four years is seen as just as important.

Under chairman Ben Bernanke, the Federal Reserve has pledged to keep interest rates at record low levels until 2015 and aggressively pursued $2.3trillion worth of quantitative easing (QE), or printing money.

Should Obama get over the line on Tuesday, then Bernanke is likely to get a third term when his current one ends in early 2014 or someone with a similarly aggressive approach will take over. The big question for bond and currency investors is what Romney would do.

During his fight to become the Republican nominee, the former governor of Massachusetts was up against opponents who profoundly disagreed with QE or, in the case of Ron Paul, wanted to abolish the Fed altogether. Then, Romney voiced his concerns about Fed policy, but it remains unclear what approach he will take.

"The jury is out on how hardline or ideological he would be," on monetary policy, said Shahab Jalinoos, a currency analyst at UBS.

Priya Misra, a bond expert at Bank of America, says that whatever Romney claimed trying to win the Republican nomination, no president will want to upset the bond markets early on in office. "Romney is ultimately a pragmatist," she explains. "No one wants to come in as president and appoint a Fed chairman that the markets don't like. You'll get a moderate Fed chairman."

In practice, she says, that will translate into a similar commitment to keep interest rates low and possibly extend QE. Even if Misra is right, a Romney victory would inject real uncertainty into monetary policy for the first time since the financial crisis began.

The third and, arguably, most important question bond markets will be trying to answer on Wednesday morning is whether after the election it is more likely the US will be able to deliver a major agreement that reduces its $16trillion of debt without hurting a recovery that the rest of the world is still looking to help power the global economy next year.

It is an agreement that has eluded Obama and Congress over the last three years. Unlike Britain and some countries in the eurozone, the US has not come under any pressure from bond investors to address its deficit and has continued to be able to fund it cheaply. The yield on the benchmark ten-year US bond touched a record low earlier this year and closed at 1.72pc on Friday.

That compares with 1.86pc for 10-year government bonds in the UK, where the government is tackling the national debt. The lack of pressure is unlikely to last for another four years. "The president that takes power is the one who will have to do something for the long-term on America's budget," says Misra.

Starting on Wednesday, financial markets will begin to get clues as to whether the US will be capable of delivering such a debt deal over the next four years.

http://www.telegraph.co.uk/news/worldnews/us-election/9654138/The-three-questions-bond-investors-are-asking-about-the-US-election.html