Fedwatch/Campaign Watch: Kemp on the Move Jude Wanniski and David Gitlitz September 27, 1996

FEDWATCH: BEARS ON THE RUN: Whatever lingering hold the bond bears may have had on the markets — to cast doubt on the wisdom of the Fed's Tuesday decision to pass on a rate hike — has been broken. By every available indication, confidence in the dollar's purchasing power has been augmented, rather than diminished, by the Fed's non-action. Gold is at $381 today, down from $382 prior to the Tuesday meeting, and the long bond is below 6.9%, compared to 7.02% early Tuesday. All the dire warnings of a sinking of the dollar because of failure to raise interest rates on U.S. debt were exploded as the greenback climbed against the yen, to almost 111 from less than 110. It wouldn't surprise its to learn that the nearly two-point gain in the 30-year Treasury since Tuesday has been aided significantly by the bears finally giving up their pretense of gloom and covering their shorts.

As we see the developing constellation of forces, this rally could have some staying power. At the short end of the yield curve, 3-month T-bills have dropped by 30 basis points since Tuesday, in direct correlation to the voiding of an expected Fed rate hike. This has produced a quick widening of the bond-bill spread to about 200 basis points from 185 Tuesday. Provided that the bears do not succeed soon in fanning the embers for a rate hike again, we expect a fairly quick reversal of this curve steepening, with long rates falling to restore the general shape of the earlier curve. This alone should get the long bond yield down to the vicinity of 6.75%. Beyond that, the nation's creditors will have to be convinced not only that Alan Greenspan has no intention of cutting off the expansion with an ill-advised tightening, but also that there is no sign of increased risk to the long-term purchasing power of their assets.

On that score, the results of Tuesday's FOMC meeting were highly positive. Had the Fed raised rates, it would have confirmed the worst suspicions that the current lineup of the central bank believes that too many people working causes inflation. We have long known that Greenspan himself entertains no such fallacies. But the inside leak to Reuters last week, that eight of the twelve regional reserve banks were pressing for a discount rate hike, was cause for concern. We could not be sure Greenspan would have the maneuvering room to steer the full FOMC toward accepting a stand pat posture. With none of Greenspan's favorite early warning signs of inflation (precious metals, exchange rates, yield spreads) indicating the need for higher rates, a funds rate increase would not have inspired confidence. After all, if the Fed can tighten when these sensitive market signals of incipient inflation are unthreatening in order to restrain the real economy, it can also ease when they are less benign to propel "growth." Such a posture would obviously increase the monetary risk of holding dollar assets. As it turned out, Greenspan went some way toward securing the faith of the markets that he is operating from a near-optimal policy paradigm. The market response suggests that instead of raising questions about the Fed's anti-inflation resolve, the outcome of Tuesday's meeting significantly enhanced it. Indeed, should the gold price now begin moving below the $380 level, the bond bulls would have a shot at turning market sentiment toward speculation that the Fed's next move might be to lower the funds rate.

Until then, the approach of the post-election FOMC meeting in mid-November still poses a test for the markets. We see little reason for expecting a rate hike for the balance of the year, no matter the outcome of the elections. Greenspan should have less need to worry about his Fed colleagues pursuing their own agendas for this meeting. In Wednesday's New York Post, columnist John Crudele persuasively fingered the source of last week's inside leak to Reuters as Laurence Meyer, one of the Fed's two new governors. Meyer apparently allowed himself to be charmed by Isabel Clary of the news service. She had written a gushy profile of him, and he appears to have rewarded her with the scoop. It's a safe bet that Meyer will be extremely cautious about straying from Greenspan's side for quite some time.

David Gitlitz

CAMPAIGN WATCH: KEMP ON THE MOVE: Kemp's first time out on national television since the GOP convention, last Friday on "Larry King Live," was so successful that the Dole campaign has lengthened his leash. He taped an hour-long David Frost interview which is scheduled to run on tonight at 10:30 EST PBS. We hear second-hand that he likely will make waves again with his comments on Louis Farrakhan, prompted by Frost inquiries. It isn't certain, but it would be odd if Farrakhan does not respond to Kemp's high-risk initiative during the black political convention that convenes today in St. Louis. Farrakhan has not uttered a public word since Kemp's Boston Globe interview two weeks ago praised Farrakhan's Million Man March speech of a year ago, and Kemp's subsequent challenge to Farrakhan to once and for all renounce anti-Semitism and bigotry. If there is going to be a breakthrough for the Dole/Kemp ticket among black voters, who are now almost solid for Clinton/Gore, it is most likely to come through a decision of black males between the ages of 18 and 45, those who see Farrakhan as their best shot at breaking out of the dependency of the Democratic liberal plantation. I'd be surprised if Farrakhan did not give Kemp enough satisfaction to his challenge to put the reconciliation ball into the Jewish court. The story would mushroom, and seeing what is at stake, the Democratic establishment would have to pull all the stops to counter this move to Clinton's vulnerable left.

It is also a do-or-die week for the GOP ticket in California, with Kemp assigned to spend the week trying to upend Clinton's enormous lead. The Farrakhan issue could trigger heightened attention to Kemp's presence in the state. He'll speak at Silicon Valley on Monday to talk about economic potential and the importance of the GOP tax cuts, especially on capital gains, in an audience that should easily recall Clinton's broken promises to them in 1992. In the skeptical black and Hispanic communities, Kemp has to answer his "flip flops" on the California referenda on immigration and affirmative action. He is already firing shots at the Clinton administration for having caused the immigration problem in the first place by giving poisonous advice to the Mexican government in the fall of 1994 on the need to devalue the peso. The New York Times and other friends of Bill have recently been praising him to the skies for having saved Mexico with a $20 billion bailout. We still regard that fiasco as one of the greatest financial scandals in U.S. history, involving so many Establishment people and institutions that we have doubted it would ever be seriously investigated. Dole and Kemp, who actually saw eye to eye on the peso crisis as it unfolded and tried to limit its damage to the Mexican people, are in a perfect position to hammer away at it. It makes Whitewater pale by comparison.

There is really no reason why the presidential campaign cannot turn in the five weeks remaining. For all practical purposes, Kemp is now playing quarterback and Dole is in the owner's skybox, where he belongs, cheering his #1 draft choice on. As long as he completes passes and avoids sacks, he can move the team down the field with the material he has. President Clinton still has a big lead, although down to 10 points in today's CNN poll, but he has no new plays in his play book, and no one to come off the bench to help him.

Jude Wanniski