Weekly Comment on the Markets, Politics and Economics by Alastair Winter, Chief Economist at Daniel Stewart & Co.

After a jittery three weeks of relief about the taper offsetting bewilderment over a possible default, US equities have a better week in prospect. If it has been understandable to boggle at the surrealism of the Republicans' (the Grand Old Party, for Heaven's sake!) contemplating marching the US economy over a fiscal cliff (with repercussions beyond) it will surely also turn out to have been right to doubt they would actually do it. It is taking quite a bit of nerve not to take evasive action just in case but many investors got burned by the cost of doing so two years ago. Of course, the great consolation throughout has been the realisation that the FOMC will postpone any tapering at least until this latest confrontation has been resolved.

The shenanigans in Washington may seem bizarre to most foreign observers but, under the influence of the eighteenth century political philosopher Montesquieu, the US Constitution does empower the Legislative to challenge the Executive. To those of us in Europe, it also strange that such a vigorous challenge would be mounted over universal healthcare but the Obamacare legislation is sufficiently flawed at least to justify some sort of constructive debate. Nevertheless, the GOP opted for sabotage and now they must very soon pay the price by settling on Mr Obama's terms. Both sides will probably keep up the rhetoric for a few more days but House Speaker Boehner has already signalled that there will be no default. The sense of a phoniness has been increased by the Pentagon's already calling back to work many of its workers laid off for all of 4 days and by Congress's unanimously agreeing to pay all federal employees retrospectively. A full budget deal may take longer as both sides want to replace the sequester but an interim deal should be enough to open up the government again. If all else fails, there is an argument that the Treasury already has the authority under the Constitution to preserve the full faith and credit of the US. For now, Mr Boehner is resisting taunts to hold a vote in an attempt to wring some concessions but there are probably already enough GOP members of the House willing to vote with the Democrats in approving the President's proposals.

An accord could well be reached by the end of this week but even in that eventuality Mr Bernanke has probably already decided to postpone the start of the taper until, at the earliest, his last FOMC meeting as Chairman on 28-29 January and he could leave it to his successor at the meeting on 18-19 March. The shut-down will provide the pretext he needs: the September Unemployment numbers have already been delayed and the ones for October may never be collected. With the production of other official data also being disrupted, the FOMC will be unable to complete the analysis that it has announced will determine its decision on tapering.

Accordingly, assuming the politicos in Washington manage to avoid default, the prospect of another three months or more of QE is likely to be the main market mover.

· In the US, it should cushion any potential disappointment on Q3 corporate earnings.

· Equities in the UK (especially the more international FTSE 100) and Emerging Markets should also benefit.

· In contrast, equities in Japan may struggle because of the effect of extended QE on the USD/JPY exchange rate.

· Equities in China continue to march to a different drum to much of the rest of the world and may, especially if there are any real or imagined leaks, move sharply in anticipation of the batch of monthly data due out in the week beginning 14 October.

· Milan and Madrid may continue in the party mood following the survival of the Letta government, which it is assumed will avoid an immediate new EMU crisis. They have nearly caught up with other European markets in respect of the levels of a year ago but are still a long way behind looking further back.

· US Treasuries have prima facie not been much troubled beyond some uneasiness over very short-dated T-bills and a deal in Washington should lift any pressure on yields.

· Bonds elsewhere, including gilts, may move in sympathy with US Treasuries while those in Italy and Spain have already been celebrating Mr Letta's survival.

· The dollar could well lose more ground because of the likely QE extension but some central banks in Asia and Latin America may feel they can rein back their intervention.

· Mr Draghi's continuing concerns over growth in the EMU has restrained the effect on the euro of developments in Italy.

· The pound may well see more profit-taking as more investors are persuaded by the apparent unity within the MPC over interest rates and the reduced prospects of pressure from rate rises in the US and EMU.

· Gold, Oil and other commodities could well perk up at the prospect of extended QE but rallies are unlikely to be sustained in the absence of more convincing evidence of rising global growth.

The City - FreeFoto.com

The City – FreeFoto.com

Of course, the possibility of a prolonged shut-down and some sort of default cannot be ruled out entirely. This would take investors into unchartered territory and threaten the international financial system. It is too simplistic to suggest that Gold, bunds, gilts, the yen and the euro would be havens while equities, US Treasuries and the dollar collapsed. Something like that could happen in the very short-term but markets are so inter-connected that there could be some strange outcomes. Just thinking about it adds to the conviction that a deal will be done this week or next!

Whatever happens, no good will come from the shoot-out in Washington. The Tea Party will still menace the GOP grandees and the Democrats will not give up Obamacare. Last week, I suggested that a future Edward Gibbon might attach great significance to these events in tracing the US's Decline and Fall. Somewhat ominously, much 'face' and maybe worse has been lost in Mr Obama's having to stay at home while Messrs Xi and Putin strut the stage in Bali at the Asia-Pacific Economic Co-operation meeting. Equally ominous, if not quite as humiliating, is the inability because of the shut-down to send a delegation to Brussels to start the negotiations for the Transatlantic Trade and Investment Partnership. Aaaaargh!

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