When we scan the horizon these days for news that will impact Wall Street one way or another, there are a few worrisome problems on the geopolitical front and a Federal Reserve Board still making policy in the dark. Our biggest concern is that there is not much coming down the pike to cheer things up. This means we have to hope for an unexpected bolt from the blue, or in the period just ahead expect a steady drizzle over equities. Here is a quick rundown of what`s ahead, good and bad.
IRAQ: I`m afraid the recent weeks of happy talk about democracy coming to Iraq will soon end with the realization that nothing will change when the new government is formed. As long as it is evident to me that it is in fact a creation of the U.S. government, with a Prime Minister, President and Cabinet composed of men who sided with Iran in the Iran/Iraq war, it will be evident to the insurgents that it is a puppet regime to be ignored at best, targeted at worst, and the violence will increase. The price of oil will remain high, not because there is snowfall in New England or Finland, but because the insurgents are getting better at blowing up pipelines. There are backdoor contacts with the insurgents, to see what they will settle for, but we`ll see they want the U.S. army out and the newly elected National Assembly dissolved. For the U.S. to stay would mean another 40,000 or so troops, but enlistments are already falling off a cliff, and it seems most unlikely the administration will ask for a draft. The Washington Post reported Sunday that there are now more corporals than privates in the army, the result of the "aging" army.
ISRAEL/PALESTINE: There is also more happy talk coming out of Israel on fresh commitments to make a deal with the Palestinian Authority, pull out of Gaza, release Palestinian political prisoners, etc. But it is only February and there will be no action in the settlements until July. In the next four months, the chances of the "peace process" unraveling with provocations on one side, the other, or both, are not 100%, but close to it.
BUSH IN EUROPE: If there was any chance the President would devote his European tour to listening to gripes and suggestions from the EU establishment, it ended immediately with his lectures on how they all better shape up and get with the democracy program. He asked his hosts to join him in yapping at Russian President Putin on that score (which they will not do), to not end the arms embargo against China (which they will do), and to send specialists to Iraq to help train a police force of 200,000 by October 1. They agreed to train 1,000 at a location outside Iraq. The President made a fuss over French President Jaques Chirac, but could not even persuade him to put Hezbollah on a terrorist list. It looks like he will come home with an empty bag.
KOREA: Our friends in South Korea would like nothing better than have the Bush administration take their advice on how to handle Pyongyang, and so would the DPRK`s other neighbors, including China and Japan. The President, though, is still thoroughly in the grip of his neo-con advisors, even more so with the elevation of John Negroponte to the top of the intelligence pyramid. Uncle Sam is the Boss and anything less shows weakness, they figure, so Seoul has announced that it will tear a big chunk out of the $200 billion in Treasury bills and bonds that it holds and trade them in for other reserve assets. That little kick in Uncle Sam`s pants may not have been responsible for all of the 175-point decline in the DJIA yesterday, but the Koreans can take credit for much of it. One hopes that eventually Mr. Bush will realize the limitations of empire, but we can`t expect it anytime soon. We`ll see how he handles Mr. Putin on Thursday.
GREENSPAN: The Fed chairman`s admission last week that he can`t explain the reaction in the credit markets to the increase in the funds rate did not win him any points for honesty in the financial markets. The yield curve should be shifting upward, he opined, but is instead flattening. It`s a "conundrum." The price of gold had been declining nicely with "good news" from the economy in previous weeks that suggested there would be a slowdown in the Fed`s quest for the natural interest rate. But Wall Street interpreted that Greenspan implicitly approved of that puzzling development, which meant there would be more and bigger hikes over the course of the year. Bear Stearns, the main cheerleader for higher rates, now thinks the funds rate will end the year at 4.5%, which would mean a 50 bbp hike at one of the FOMC meetings, and then hang out at 5% in 2006. That may happen if Greenspan doesn`t face up to the fact that his program has been causing inflationary creep, and shift strategies. Bear`s John Ryding actually thinks the Fed is now "more accommodating than it was when the Fed had a one percent interest rate last year." He fails to mention the gold price is $45 per ounce higher than it was a year ago.
REFORMS: There should be good news for Wall Street in the Social Security and Tax reforms that are on the Republican agenda for 2005. So far there is only mass confusion on what shape the reforms will take and whether they will be dealt with seriatim or in parallel. The President`s push for Social Security privatization is meeting great resistance at the grass roots, almost certainly because it is not being packaged with tax reforms as recommended by House Ways&Means Chairman Bill Thomas. The conservative think tanks are beginning to sound hesitant on privatization, thinking a little tinkering might fix Social Security and avoid the nasty politics that may lead nowhere in the end anyway. Meanwhile, the U.S. Chamber of Commerce has cooled to the idea of tax reform, worried that business will get the short end of the stick as it did in 1986. The only positive scenario we pick up is that somehow Bill Thomas will make a big push when all seems lost later this year and everything will work out for the best. Hmmmm.
BOLTS FROM THE BLUE? About all we can hope for in the near term are nice surprises that might include the following: 1) A light at the end of the Iraqi tunnel that shows real promise of U.S. troop withdrawals; 2) Treasury Secretary John Snow taking some bold steps to ease the burdens of Sarbanes/Oxley; 3) Greenspan figuring out the "conundrum" and abandoning the current strategy; 4) an outbreak of bipartisanship on Capitol Hill on the reform elements, making it clear there will be lower capital taxes in whatever legislation results; 5) Some other as yet unknown bolt from the blue.