A Blue, Blue Wave + Aggressively Hawkish Fed: A Recipe For Disaster?

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by: Bill Kort

"the Sixty-Four Dollar Question"

What's gonna happen if the Democratic Party gets its Blue Wave this Tuesday?

My thoughts are as follows:

  • One way or another, this will be an obsession. If both houses go to the Democrats there will be a major media freakout/ feeding frenzy focusing on the negative: the Democrats… their business-unfriendly bias, their desire to reign in the business-friendly tax breaks ushered in last year and provide greater tax cuts for the middle class.
  • This obsession could likely drive the market lower on a short-term basis as those corporate cuts have given a big boost to earnings this year. Reversing them would very likely cause an "earnings recession" where corporate earnings would show a decline (without a part of the benefit from the lower tax rate) while the overall economy continued to grow. We had one of these in 2015/2016 because of a collapse in oil prices and the adverse effects of a very strong dollar.
  • Not to worry… Nothing along this line is likely to happen as long as Donald Trump is President. What about impeachment? Unless the Mueller Investigation comes up with super-clear evidence of "high crimes or misdemeanors" that is very unlikely. Even if they hold a trial in the House of Representatives and convict the president, the Senate would be a very heavy lift. In the House it only requires a simple majority to send charges forward to the Senate for a trial (doable). However, in the Senate a 2/3 majority vote (67 Senators) is required to impeach (maybe not so doable).
  • Oh yes, lest we forget, even if impeachment occurs, Mike Pence would still be Vice President. It would be very unlikely for Mr. Pence to do or sign anything reversing current tax policy. I guess the Vice President might have some skeletons in his closet (i.e., he may have legal problems). But, for now, there appears to be nothing on the table alleging anything of this nature.
  • Worst case for the market is that with a Republican House (or House and Senate) Donald Trump immediately becomes a lame duck. With most of the party's policy agenda taken care of, that may not be such a bad thing. A positive here is that it is Congress' constitutionally appointed duty to set tariffs and duties. If they reassumed that responsibility, I think the market would like it.
  • One last item as it pertains to taxes: as it took many years of wrangling to cobble together the last tax change legislation, it would likely take many years into the future to create a new program. Many good things pertaining to economic growth and prosperity could happen between now and then. I would not be using potential tax code changes as a reason to be out of stocks.

The Other Prime obsession - The Fed


Federal Reserve Bank of the United States

Everybody (a significant majority in the punditry corps) is on the Fed's back for increasing rates or increasing rates at too rapid a rate. I do not get it. Fed policy continues very accommodative. Yes, they have been shrinking the balance sheet (selling) to the tune of about $50 billion per month. When Quantitative Easing was applied, they were buying $84 billion per month. To put these amounts into context, the September average daily trading volume (I repeat daily) in US Treasury securities was over half a trillion dollars. Ergo, $50 Billion in Treasury sales in a month is not material. It is a drop in the bucket.

With respect to the pace of interest rate increases, it has taken the Fed almost 3 years to move the Fed Funds rate from .25% to 2.25%. It has been five years since the 10-year US Treasury note traded at a 3% yield (the record low of 1.36% actually occurred after that in July 2016) All the way there has been a choir of pundits warning that higher rates would drive us into recession or worse. The 10-year went out at 3.22% Friday, 11/2 (still down from a post-Fed rate increase high of 3.26%). This is not untypical of price reaction of the 10-year to moves by the Fed. With the market weakness of the past week or two, the flight-to-safety trade had driven the yield on the 10-year even lower (3.077%).

On the issue of Fed Policy, there is no reason to believe that their policy assessments will be made in any different manner than previous Feds. Their policy will be 'data dependent.' Since we have already used the fiscal tool of a massive tax cut mentioned above, Fed rate cuts may be the only implement we have to bolster the economy in an emergency. My contention is that these rates are still incredibly low and that we need to increase them to build the Fed's safety valve.

To answer my title question: A Blue, Blue Wave + A Hawkish Fed is definitely not a recipe for disaster!

My recommendation for Tuesday: always think for yourself and vote!

What's your take?