As investors, we detest sharp-cornered outcomes associated with political decisions. Binary choices include yes or no to a referendum, Republican or Democrat as US president, or principal payment versus default on a bond. While the event happens after the fact with the probability of zero or one, before the fact markets assign a probability between zero and one (unless the result was painted on the wall by surprise-averse officials such as those populating the Federal Reserve). When politics are in play, it is hard to have a forecasting edge, a point call may turn out to be completely wrong, and financial prices are sure to adjust on the resolution of the event as the probabilities embedded in valuations move to zero or one.
A particular irony is from the other perspective—sitting as a policymaker in front of a discrete event—the discipline of a sharp corner sometimes elicits calming behavior in the official community, mostly in a manner similar to adventurers sneaking around the sleeping jungle cat in the movies. In the current environment, we think that there are four sharp edges in the future that increase our confidence about the near-term outlook, even though this may be understood, in retrospect, as living in the calm before the storm. And besides, we believe that, now the Fed has a cushion for its policy rate above the zero lower bound, central bank officials would step into the fray to diffuse market strains if political outcomes are somewhat more ragged than expected.
The corners in our future include: