Clinton/Lott Government X/Fedwatch Jude Wanniski and David Gitlitz May 19, 1997

BUDGET DEAL II: The news Friday about the GOP leaders and the President getting their budget deal on paper did not tell us anything we did not know. They only had a concept before they put it on paper and a concept is all they have now. It is nice to know that Mssrs. Clinton, Gingrich and Lott do understand that Chairman Bill Archer of House Ways & Means and Chairman Bill Roth of Senate Finance have something to say about tax policy. Newt, who 10 days ago was talking about replacing Archer for saying he would not be bound by Newt's deals with the White House, has pulled in his horns. Archer is not going to be satisfied with anything less than a 50% exclusion on capital gains and prospective indexing. To get it within the tight confines of the overall package, Archer knows he's going to need Congressional Budget Office and Joint Tax Committee revenue estimates that are at least partially based on a dynamic scoring model. Ideally, the mid-session revision of CBO's economic assumptions would include a higher projection of future growth based on the capgains rate cut, with the additional tax receipts offsetting the static revenue loss. Short of that, Archer still could get a good part of the room he needs with a revenue estimate that incorporates the unlocking effect of a capgains reduction on the $7 trillion in unrealized gains now on the books. To make this happen, all that's needed is a letter to CBO and Joint Tax signed by Lott and Gingrich, directing that the revenue estimates encompass the dynamic effects of the tax cut. We don't have much doubt that Lott would be willing to sign such a letter today. Gingrich could be more of a problem. Given his weakened condition, he may not have much enthusiasm for facing down the class warriors in the Democrats' Gephardt wing. Already less than enthralled with the deal cut by the White House, they can be expected to be in full cry against any GOP-engineered maneuver to ensure a meaningful capgains cut.

Jude Wanniski and David Gitlitz

FEDWATCH: Today's yield movements, with the 3-month bill up 10 basis points while the long bond trades down just a few ticks to yield 6.91%, suggests the credit markets are discounting a better than-even chance of a 25 basis point Fed funds hike tomorrow. The price of gold dropping another $2.50, to $341.50 per ounce — after brushing against the $350 mark last week — also suggests that the commodity markets are braced for another FOMC move tomorrow. While we would dispute any notion that current conditions reflect a risk to dollar purchasing power requiring further Fed action, today's adjustments at least indicate the market won't be caught off guard if the FOMC pushes its funds rate target up to 5.75%. Looking ahead, we continue to rate the prospects of a bond rally as better than not, regardless of what the FOMC does tomorrow (see Fedwatch, May 15, 1997). Others assert that the Fed would actually sow more uncertainty if it remains on hold, leaving the market pointing to the July FOMC meeting as the next hurdle to be overcome. Our hunch, though, is that if Greenspan has another tightening in him, it will come tomorrow. If not, the premium now built into yields on the risk of additional Fed action should dissipate, setting the stage for the rally.

DG