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Republican win in US election may mean a shackled Fed Bank

LONDON--Investors staring squarely at the U.S. fiscal cliff may well be ignoring a bigger monetary policy pitfall.

Many asset managers are puzzled at the how little attention world markets seem to have paid to the U.S. Republican party's stiff criticism of the hyperactive Federal Reserve and its successive bouts of reflationary money printing since 2008.

Given the scale of support the Fed — along with the European Central Bank, Japanese and British central banks — continue to provide global asset prices, then it's remarkable how little markets have been ruffled by next month's tight election race. This past week's first of three U.S. presidential debates was a starting gun for a month of intense electioneering that is at least starting to focus minds on how markets may behave around the Nov. 6 poll.

To date, most of the talk has been how quickly the next president and new congressional constellation can dodge the looming “fiscal cliff,” where US$600 billion in spending cuts and expiring tax relief — some 4 percent of U.S. output — kicks in automatically next year without a wider budget agreement.

But with such an agreement as dependent on the makeup of the House and Senate as the occupier of the White House, this budgetary uncertainty has been parked in “watch, wait and see” mode until the election outcome becomes clearer.

The running assumption is that one form of “gridlock” prevails and a deal gets thrashed out in time. On balance, the polls point to incumbent Democrat Barack Obama retaking the presidency, Republicans the House, and the Senate up for grabs.

But if Republican challenger Mitt Romney's strong showing in the first debate on Wednesday night translates into opinion poll gains both nationally and in key swing states, then the prospect of a “clean sweep” for Republicans may have to be priced into markets rather quickly.

That could well have profound impact on everything from the “fiscal cliff” resolution and growth outlook to equity sectors like pharmaceuticals, wary of a rollback of Obama's healthcare reforms. But upshot of sometimes bitter Republican criticism of the Fed is potentially even more disruptive for world markets.

Republicans have long argued that five years extraordinary Fed policies ultimately threaten future inflation and abet profligate spending in Washington.

Romney has vowed that if elected he would not renominate Fed chief Ben Bernanke, himself a Republican, to a third term.

And Romney's running mate Paul Ryan is an even harsher critic, backing legislation that would open up the Fed's monetary-policy decisions to congressional scrutiny and strip the central bank of its mission to seek full employment.

Given that the longevity of the Fed's third round of asset purchases last month is tied explicitly to cutting the jobless rate, that's a particularly controversial stance going forward.

“If Mitt Romney is elected as the next president there is going to be a phase during which investors are going to be concerned that he might remove Ben Bernanke from the Fed,” said Yves Bonzon, chief investment officer at Swiss asset manager Pictet, which has over US$300 billion in assets under management.

“And if that happens, if Romney is elected, you want to hedge all dollar-debasement trades. That includes gold, the S&P 500, carry trade currencies etc.,” Bonzon said.

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