The elections last night mean no real change with respect to the political deadlock that produced so much noise during the debt ceiling negotiations in 2011. The results from last night do not produce a material change to incentives, even though they can be interpreted as a message for ‘balance’ in the approach. Though we believe 2013 is bound to be better than 2012 from an economic fundamentals point of view, the next 2 months can produce real noise and potentially damage to that outlook.

Last year the debt-ceiling negotiations led to a downgrade of US debt, and market volatility, as the two parties could not agree until the last minute. Their agreement back then was nothing but a postponement of the real negotiation, with an enforcement mechanism that threatened with recession if an agreement was not reached through time. That negotiation has not happened yet, and it should happen now. The fiscal cliff, which is triggered on January 1^st, forces for a quick fix now, in order to provide time once again for a more profound negotiation on fiscal and tax reform. We believe that the result last night leads to a higher probability of a messy 2 months on this topic. In fact, President Obama used that word, ‘messy’, when referring to the upcoming negotiations during his campaign. This is not good news for the markets in the short-term, and it could affect the medium-term given the weakness of the gradual economic recovery.

On the side of President Obama, who campaigned on the idea that the fiscal adjustment has to be done on a balanced way, with some revenue increases, they will feel the elections provide a mandate for higher revenues, to be generated mostly from the higher brackets.

On the Republican side, they not only retained the House of Congress, but also increased their position there, and the elections provide no clear change in incentives to maintain their strict adherence to the idea of no significant increases in revenues.

Public opinion and the business community appear to clearly favor compromise, but the parties face no real change in their incentives to compromise, at least not in the first round, which means we are bound to see a messy 1-2 months of negotiations. We could even see them going over the cliff.

We continue to believe there is a broad consensus around the need for both tax and fiscal reform, and that it is bound to happen during 2013. We believe that the US economy is picking up pace slowly. It is still the most flexible and biggest economy, it has a natural tendency to grow, though current challenges can mean a slower pace. And economic data from Asia and Latin America point to gradual fundamental improvements. But the next two months could produce a non-trivial shock if not properly managed by politicians, especially President Obama.