Key Dates Approaching
October 25 – October 29, 2010
Dr. Scott Brown, Chief Economist, Raymond James
The first week of November looms large for the markets. The November 2 mid-term elections are expected to result in a power shift on Capitol Hill – but how much will actually change? The Fed’s November 3 monetary policy decision has important implications for interest rates, the dollar, and the economy in general. The October Employment Report (due November 5) will help shape the near-term economic outlook and set expectations for future Fed policy moves.
For those of you who slept through civics class in high school, recall that all 435 seats in the House of Representatives are contested every two years. Senators serve six-year terms – so about of third of the 100 seats in the Senate are contested every two years (37 seats are being contested this year, due to the death of Robert Byrd and the resignations of Joe Biden and Hillary Clinton). As we head toward the wire, there are a number of close races. Recent polling suggests that the Republicans have a good chance of regaining a majority in the House and a small chance of taking control of the Senate.
Will the election results change anything in Washington? It will in the House, where a simple majority is needed to pass legislation. The Senate is more complicated. As it is now, the Democrats have a 59 seat in the Senate, one short of a supermajority. You need 60 votes in the Senate to avoid the threat of a filibuster – and thus, you need 60 votes just to be able to vote on a bill. In addition, one senator can put a hold on any or all legislation, meaning that the floor leader is informed that the senator does not want a particular bill to come to the floor for a vote (and implicitly threatens a filibuster of any motion to consider the measure). So, anyone believing that a Republican victory will lead to a dramatic change in the direction of legislation will be disappointed.
Yet, perceptions matter. The stock market is likely to view a Republican majority in the House as a check on the White House. During the Clinton years, gridlock was good. The Republicans didn’t get massive tax cuts and the Democrats didn’t get any major spending programs, and we ended up with a federal budget surplus (the Clinton era was also well served by PAYGO rules, which required any legislative changes to be budget neutral). However, in the current environment, stuff might actually need to get done to boost the economy. While there are bound to be disagreements about the best way to do this, nothing significant is likely to get done.
The Fed’s November 3 policy decision is not a done deal. There are differences of opinion, but most Fed officials, including Chairman Bernanke, have been leaning toward further monetary accommodation. The key element is expected to be an announcement to purchase a specified amount of long-term Treasuries over a certain period of time. This should be on a much smaller scale than in the first round of credit easing ($1.25 trillion in mortgage-backed securities and $300 billion in Treasuries purchased last year), allowing the Fed more flexibility (to do more if needed or to stop if growth picks up). Will quantitative easing be inflationary? Yes, hopefully – at least to some extent. Inflation is too low for the Fed’s comfort. It’s real (that is, inflation-adjusted) interest rates that matter. The drop in inflation expectations has lifted real rates, dampening the pace of economic growth. Raising inflation expectations would lower real rates, stimulating growth. Still, it’s not an easy decision. There are positives and negatives to just about any Fed policy decision. Many fear that the Fed will not be able to withdraw accommodation in time and fuel substantial higher inflation in the future. However, officials are confident that the Fed can drain bank reserves in a timely manner when appropriate. The Fed has spent much of this year testing the exits (reverse repos, term deposits for depository institutions).
The Federal Open Market Committee may announce efforts beyond asset purchases. It may commit to a longer period of low short-term interest rates. It could also announce an inflation target or a target rate for long-term Treasury yields.
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After the shock and awe of the mid-term elections and the Fed policy decision, the financial markets will face the October Employment Report. The impact of the 2010 census is behind us. Since January 2009, federal government payrolls have risen a bit less than the rate of population growth (so much for the “massive” expansion of government). State and local government payrolls have fallen, reflecting budget strains (despite federal aid to the states), which has acted as moderate drag on overall economic growth. Private-sector job growth has been positive, but relatively subpar in recent months. Expect more of the same in the job report for October.
Copyright (c) Raymond James
