A resolution to the fiscal cliff will provide a powerful boost to US equities

US Federal Reserve Chairman, Ben Bernanke, is right about two things. The first is that monetary policy is no panacea for America’s economic ills, and the second is that a fix for the impending fiscal cliff will provide a boost to the US economy and financial markets.

It’s rare that I agree with Ben Bernanke on anything, in fact this may well be a first, but in his latest speech to the Economic Club of New York on Tuesday, he said two things I agree with.

Speaking as the Marriott Marquis Hotel in Times Square, Bernanke reiterated that the Federal Reserve’s “highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens”. However he then went on to say that “while monetary policy can help support the economic recovery, it is by no means a panacea for our economic ills.”

In fairness, Bernanke has said this before, but this time his message seems to be directed at members of the US Congress who are locked in negotiations to try to avert the so-called fiscal cliff.

The fiscal cliff is more than $600 billion worth of automatic spending cuts and tax rises that are due to come into effect on 1 January 2013 if the law is not changed.

Bernanke, noted that “uncertainty” about the fiscal cliff and the ability of Congress to raise the debt ceiling in a timely manner, together with the long-term challenges of balancing the budget appear to already “be affecting private spending and investment decisions and may be contributing to an increased sense of caution in financial markets, with adverse effects on the economy.”

Congress is due to adjourn on 14 December for the Christmas holiday season giving them just 24 days to reach an agreement. However president Obama and some Democrats have suggested that Congress should stay in session throughout Christmas if necessary to prevent the spending cuts and tax rises taking effect, and House Minority Leader Nancy Pelosi, has said that House Democrats are prepared to stay in town for Christmas, Hanukkah, Kwanzaa, New Year’s and Boxing Day if that’s what it takes.

If Congress fails to reach an agreement the Congressional Budget Office (CBO) predicts that the US economy will return to recession in the first half of 2013 and that US unemployment will spike. However initial talks between the Speaker of the House of Representatives, John Boehner, and President Obama have been encouraging and I expect an agreement to be reached.

In his speech Bernanke concluded by saying that “a plan for resolving the nation’s longer-term budgetary issues without harming the recovery, could help make the new year a very good one for the American economy.” A good year for the US economy should also translate into a good year for US equities, and this is the second point on which Bernanke and I agree.

US businesses are holding off, and cutting back, on investment in new projects, equipment and hiring due to uncertainty over future tax policy. The resolution of the fiscal cliff should help to restore business confidence allowing US firms to begin deploying their record cash reserves. This, in turn, should help to boost confidence among investors.

The resolution of the fiscal cliff is likely to provide a powerful catalyst for the financial markets, and I also believe that the Fed and other central banks will find new ways to spur money velocity and get liquidity moving through the economy.

As a result the deflation, or rather disinflation, that has been a reoccurring theme for Western economies over the past few years, is likely to be resolved during 2013, and with a backdrop of persistent inflation I expect US equities to perform well, at least in nominal terms.

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