Thanks to Russia’s surprise intervention, Syria appears to have faded as a relevant source of risk in the short term. The new initiative was good and bad for President Obama, as it did save him from a difficult fight in congress, but it also left his credibility and leadership damaged. That blow to the credibility of the White House can lead to higher volatility in the short-term (not to mention the medium-term geopolitics question, which we do not want to deal with here). A weaker White House can change the optimal political strategies around fiscal issues for both political parties in the US, in a very destructive way.

August ended with a selloff across markets due to the upcoming September events/risks: what was then a very likely strike on Syria (with potential regional risks); the September 18^th Fed meeting when the first tapering announcement is expected (not to mention Fed succession with a possible Larry Summers nomination); the return of political fights around fiscal issues in the US (continuing resolution, debt ceiling, etc.); and, global business cycle concerns. With Syria postponed while diplomacy is given a try, and Chinese economic data pacifying hard landing concerns, focus turns to US fiscal issues and its politics, and this is where the Syria debacle could have serious consequences.

President Obama saved face by not going through votes in Congress to authorize a strike on Syria (which was not really needed), but the fact that congress was turning against an attack (following public opinion) and then Russia took the lead on the matter weakened his credibility. There are at least 2 important political fights coming up, and the new power balance could produce volatility.

The US government requires congressional approval to issue debt to fund what Congress had already approved in the budget. The limit on debt issuance (or debt ceiling) is supposedly to be hit around October 18^th. Before that, Congress needs to vote on the continuing resolution to keep spending at current levels (deadline is September 30^th). President Obama has stated he will not negotiate anything in exchange for a higher debt ceiling. Congress just needs to vote on it. His argument is not totally invalid, as it is true that Congress has already approved the spending that such new debt would fund. But Republicans have used each vote to try to advance their agenda of lower spending as opposed to higher taxes, and given the current state of affairs (a weaker Obama) they will most likely try harder. On this issue the political fight could be as bad or worse than what was seen in July 2011, when markets suffered the shock of default talk and the rating downgrade. True that markets have learnt these political fights tend to heat up to then end up with some compromise. But this time around the political calculations are affected by relative assessments of how Syria has weakened the White House. Incentives have changed in a way that both sides should push harder, fight harder, and risk more.

Additionally, the White House is about to nominate the next Fed Chairman or Chairwoman. At this point it seems President Obama is fixated in nominating Larry Summers, which would produce another serious fight in Congress for his Senate confirmation. In fact, serious opposition to Summers comes from both sides, as some Democrats have so far been more outspoken against him than fellow Republicans (who have chosen to wait and let Democrats fight amongst themselves on this one).

So, the questions are: would President Obama see these two fights as opportunities to regain credibility and show who is in charge? Would Republicans see his weakened position as an opportunity to push harder? The fiscal issues are more urgent than the Fed, as Bernanke stays at the Fed until end of January, and if a new person is not confirmed, then Janet Yellen takes over on a transitory basis as she holds the vice-chair of the Fed at the moment. In the meantime we should get the ‘tapering’ going, where we expect to see a $15 billion first reduction in buying, which is priced in to a large extent.

In sum, over the next few weeks we should monitor the political discourse, fiscal discussions, Fed nomination (and tapering), to gauge whether we will get 1-2 months of noise that could affect markets. At this point it does look like, which is why we have only moved slowly in increasing our risk exposure given the better data and postponed Syria risk.