GREENSPAN, MYER and FED FUNDS: In the wake of the Fed Chairman's NY Economic Club speech last night, the fed funds rate opened at 3.88%, well under the 4% target. Greenspan yesterday signaled almost an eagerness to step in with a lower funds target if the economy does not respond to the 4% rate. By contrast, Laurence Meyer, speaking at an investment convention in Scotland, spooked the bond market by suggesting that labor markets still were tight and inflation above an "acceptable" long run level. Greenspan, the Phillis Curve dove, and Meyer, ever the Phillips Curve hawk, are confusing the market, which responded to the uncertainty by pressing up yields at the long end of the curve. Where the market had thought we might be approaching an end to the funds deflation treadmill, it now sees it being cranked up again. Futures markets now price in more than a 100% probability of an additional 25 basis points cut in the funds rate and a 56% chance of 50 bps. Earlier this week the probability of 25 bps was 80% and the day after the Fed last cut, expectation of one more reduction in the funds rate was only 50/50. Not surprisingly, the Fed's balance sheet expanded rapidly after the latest rate cut -- by about $14 billion -- when the market guessed it might be the last. As rate cut expectations began to rise again, we observed funds trading weak, with the Fed's balance sheet contracting by $10 billion during the last week. Why bid for funds at 4% when they will soon be lower? The turn that sent equities flying last week occurred when funds traded above 4% and the Fed had to throw $11 billion in reserves into the system in one day to drive it down. Now the open-market desk has to drain reserves to get funds back to target, taking liquidity from the system and making the dollar scarce again relative to gold, the proxy for all prices. Gold has slumped back. Greenspan is still on the Phillips Curve, eyeing the unemployment rate instead of commodity prices. That's the bad news.
CAPITAL GAINS: The good news is that a capgains cut to 15% from 20% is still possible, even with the Senate in Democratic hands. In the last hours before the Senate cleared the $1.35 trillion tax cut, there was an amendment proposed by Sen. Judd Gregg [R NH] to cut the rate, and it was defeated by 51-to-47. Larry Kudlow has blasted the eight Republicans who voted against the cut, but some of the eight, including Sen. Chuck Grassley of Iowa, chairman of Senate Finance, did so because of agreements with the Democrats to not alter the basic bill. The fact that eight Democrats voted for the capgains cut, including liberal Sen. Charles Schumer of New York, tells me there are easily 60 votes for the cut should it come up after the August recess, as had been planned by Senate Majority Leader Trent Lott. The Schumer vote for capgains is a clear sign Sen. Bob Torricelli [D NJ] has been working on his Democratic colleagues, getting them to see it is a popular idea. The other six Democrats voting for it included Susan Collins of Maine, Evan Bayh of Indiana, Max Cleland and Zell Miller of Georgia, Joseph Lieberman of Connecticut, and Ron Wyden of Oregon. If President Bush makes any kind of effort to push for a 15% cut in a second tax bill, it would pass easily, I think, perhaps with 70 or more votes. The President's father, remember, campaigned on a 15% capgains tax in 1988 and gave up the fight too soon, which cost him re-election.