Republicans outvoted Democrats by about 2 to 1 at state and local primary elections recently, so perhaps the November mid-term elections could be swayed by a high Independent and Republican turnout vs. a low Democrat turnout. Clearly, President Obama will have to work with an entirely different Congress next year. The stock market loves political gridlock, so the coming political shift could be good for the stock market. After November, we could also see some tax rate relief in 2011, giving investors a break on the scheduled capital gains and dividend tax increases.
As the federal government’s fiscal-2010 budget year ends (on September 30), the federal budget deficit is clearly out of control. Last Thursday, Standard & Poor’s said that the U.S. government needs to take steps to preserve its AAA credit rating in fiscal 2011, presumably under a more parsimonious Congress. S&P has repeatedly warned that the federal government’s gigantic deficit and debt burden may cause S&P to downgrade the U.S. from AAA to AA after the November mid-term elections if concrete steps are not taken, similar to what Britain did after their May election with their ensuing “tax and axe” plan. Last Tuesday, S&P cut Ireland’s long-term rating to “AA-” and assigned the country a negative outlook, so a downgrade for the U.S. is possible, since our budget deficit (as a percent of GDP) is similar to Ireland’s.
In the meantime, the minutes from the August 10th Federal Open Market Committee (FOMC) revealed that there is growing opposition within the FOMC to the Fed’s current actions, with at least 7 of 17 Fed officials expressing reservations about further Fed easing. Despite this growing dissent, Fed Chairman Ben Bernanke told the world in Jackson Hole that the Fed is not out of ammunition and still has options.
In his speech at Jackson Hole, Bernanke acknowledged that the pace of economic growth had been “less vigorous” than the Fed was expecting and that the pace of the U.S. job growth had been “painfully” slow. Bernanke also acknowledged that the Fed was surprised by the “sharp deterioration” in the U.S. trade balance that caused Friday’s massive downward GDP revision. Translated from Fedspeak, he said the Fed will print more money and expand “quantitative easing” despite the internal debate within the FOMC.
In summary, thanks to strong business spending and faltering confidence in government spending to stimulate the U.S. economy, Wall Street is cautiously optimistic that the private sector will now drive the economic bus. Friday’s August payroll report will likely show us more evidence of that fact, with government jobs shrinking further, while private sector jobs increase, although at a painfully slow rate.
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