FT Long Short

How is the US election affecting markets? Well, it seems that investors expect re-election for President Barack Obama, and their degree of confidence about this has increased remarkably in the last week. Mitt Romney’s bad stretch, as far as the markets are concerned, seems to have finished him off. That is the subject of today’s Note video, with Gideon Rachman.

The odds from the Intrade prediction market are clear enough. As for the effect of a likely Obama victory, until the last week there has been no sign at all that stock markets find it worrying. In general, his chances of winning have risen roughly in line with the stock market for most of this year; an impressive rally has not been impeded by his chance of re-election.

However, the mini-correction since the Federal Reserve announced QE3 does overlap neatly with the sudden perception that an Obama re-election was in the bag. With many only now beginning to focus on the election, it is possible that Mr Obama is indeed beginning to scare the markets.

As far as the markets are concerned, however, the looming “fiscal cliff” – automatic tax rises and spending cuts due to take effect in January – is by far the most important issue. For this, the direction of Congress is important. And here there has been an even bigger change in perceptions.

A month ago, the Democrats were seen as having little hope of holding the Senate. Now, Intrade suggests they are almost certain to do so (the contract moved sharply even since the chart above was drawn up). A strengthening of the polls behind Democratic challenger Elizabeth Warren in Massachusetts, and Republican Senate candidate Todd Akin’s horrible comments about “legitimate rape” in Missouri are deemed to have decisively improved the odds in the Democrats’ favour. Meanwhile, Intrade now suggests that it is conceivable, although still very unlikely, for the Republicans to lose their majority in the House.

All of this suggests remarkable success for an incumbent party burdened by an unemployment rate of more than 8 per cent (and slow GDP growth that was downgraded further today). There are two main implications.

First, the “fiscal cliff” negotiations may well take place in an atmosphere of recrimination, with all the congressional powerbrokers who have failed to strike compromises for the last two years still with exactly the same amount of negotiating clout as they had before. If Intrade’s betters are right, this election will do nothing to break the log jam.

And second, conventional market wisdom may well be a long way ahead of itself.