Fedwatch: The Fed Drains Again/Hold onto your Hats
Jude Wanniski & David Gitlitz
December 6, 1994



After spending much of October and November injecting liquidity into the banking system at a rate of more than $3.5 billion per day, the Fed has made a sudden shift during this first week of December. It was capped this morning by an operation to drain reserves for only the second time since it began raising rates in February. With analyst expectations calling for no operation today, the 30-year bond, which was up by a half point prior to the Fed action at about 11:45 a.m., jumped another quarter point by 1 p.m., its yield dropping from 7.93 to 7.86. Gold continued its descent toward the $375 level. The Fed's draining, an overnight matched sale, came with funds trading 5 3/8, an eighth below target. Just as we saw on September 28, when the Fed drained the first time to push the yield up to target and instead saw it fall, the rate continued to weaken into the early afternoon, dropping another eighth to 5 1/4!! As we read the market, it is trying to suggest to the Fed that it sees no further increase in the funds rate anytime soon and that it prefers it that way.

This shift in the Fed's recent operating pattern began last Friday when it defied expectations and opted not to renew an expiring repurchase agreement for the first time since mid-October. The Fed's liquidity buildup of recent weeks had left it with more than $8 billion of outstanding repos on the books at the end of business last Wednesday. The decision to allow the repo to lapse Friday effectively drained this liquidity, and was followed yesterday by another expectations-defying decision not to intervene with funds trading on target at 5 1/2%. Thursday begins a new two-week reserve period that will carry through to the next FOMC meeting on December 20. If market indicators continue to suggest a declining likelihood of another rate increase, Fed funds will most likely stay soft, the Fed can avoid additional liquidity injections, and can then stand pat on the 20th.

David Gitlitz


We had suggested a month ago that once elected Speaker of the House, Newt Gingrich would be forced to become less partisan and that Rep. Dick Armey, the new Majority Leader, would take on that role. Gingrich was formally elected yesterday, so maybe he will become kinder and gentler starting today. We can't count on it, however. In every way he can, Gingrich is reminding the world that he is not interested in business as usual, that he believes he has tapped into the wellspring of national discontent, and that he will do whatever it takes as the new political messiah to lead us out of the depths to a land of milk and honey. His sensational Sunday performance on "Meet the Press" was both inspirational and alarming to his friends, the best and worst of Newt as one of them put it. He's at his best in challenging the counter-culture, which celebrates condom lessons and would put children in detention for saying prayers over their sandwiches in the lunch room. Or, asking NBC's Lisa Myers to choose between putting a baby in a dumpster or an orphanage. Gingrich, who was once a liberal Republican, knows how to win arguments against welfare-state liberals. His contretemps with Leon Panetta over how many White House staffers did drugs in the past five years is the kind of thing he will do less of as he grows more comfortable with his power and the White House will be grateful, knowing how savage he can be.

The worst is Newt deciding, practically on the spot, that the United States should send Colin Powell to Belgrade to tell the Serbs they had better agree to the deal we offer in Bosnia or we will bomb them to bits without even consulting NATO. A week earlier, Gingrich had been warning against the Bosnian tar baby, writing it off as a European problem. Now, he has leaped over Bob Dole in his willingness to threaten the use of unilateral force to clean up a bothersome problem over there. He is, of course, still brimming over with confidence from his historic victory November 8, which spills over into foreign policy positions. The New York Times, horrified this morning with Gingrich's willingness to bomb without question, is hiding behind Bob Dole's willingness to bomb if NATO wants to bomb (which it doesn't). 

The pace of change in this new political universe will be hard to follow for awhile -- which is why it looks so frightening to many of those who found themselves out of power a month ago after 40 years in control. Normally the departure of Treasury Secretary Lloyd Bentsen and his replacement by Bob Rubin would be worth a full week of chin pulling and analysis. But Washington still hasn't figured out what it means that Trent Lott defeated Alan Simpson for the Majority Whip post in the new Senate. The scramble of congressional staffs and committee chairmanships on both sides of Capitol Hill are producing myriad analytical variables. Until the GOP dust settles, it's probably wise for President Clinton to play more golf and concentrate on his Christmas shopping. Meanwhile, he can chew on these observations:

1. In the 1970s, when Rep. Jack Kemp of Buffalo quarterbacked the supply-side revolution inside the Republican Party, his base was in the House. His five chief lieutenants, all seven or eight years younger than he, were Newt Gingrich of Georgia, Trent Lott of Mississippi, Connie Mack of Florida, Vin Weber of Minnesota, and David Stockman of Michigan. Of the five, Stockman and Weber are gone, Gingrich is House Speaker, Lott is Senate Majority Whip and will be Majority Leader when Dole runs for President, Mack is the senior Florida Senator and will chair the Joint Economic Committee in the 104th Congress. To this day, when Joanne Kemp rings the dinner bell at the Kemp home in Bethesda, Md., Gingrich, Lott, Mack and Weber RSVP in the positive. Kemp last week arranged a meeting of Gingrich and Armey with Reps. Charles Rangel and Kweisi Mfume to open communications with the Congressional Black Caucus.

2. The Lott victory over Simpson is being viewed with great dismay by Dole's political supporters, who believe Lott will undercut Dole on behalf of Sen. Phil Gramm, a Dole competitor in the '96 sweepstakes. However, I believe Lott will actually help Dole cement his new linkages with the Kemp/Reagan wing of the GOP, which Dole knows he must do unite the party behind his candidacy in '96. It would not surprise me to see Lott broker a marriage between Dole and Kemp, their strengths and weaknesses exactly offsetting each other. Dole himself sees Lott as providing a venue to Gingrich and the other backbenchers of the '70s who now command the House. It does not surprise me that Dole, having done what he could to help his friend Simpson, is now seeing the bright side of Lott's victory. 

3. Bob Rubin, who will be Treasury Secretary, was brought into Democratic politics via Robert Strauss, who is Bob Dole's closest friend in the Democratic Party. Rubin's greatest strength now is his experience on Wall Street, where he developed an appreciation of the efficiency of the capital markets as a trader, not a banker, that exceeds all the accumulated wisdom around Bill Clinton. Rubin almost certainly would eliminate the capital gains tax if he had a magic wand, for the same reasons Alan Greenspan would do so. At Treasury, he will have Larry Summers for economic counsel, and while Summers has an imperfect understanding of the capital markets, he was among those who were most amenable to Dole's recent initiative in linking GATT to capgains. 

4. Clinton came to the White House with FDR as his role model, but that has not worked. He is now being urged to adopt Harry Truman as his role model -- a Truman who vetoed three Republican tax cuts in the 89th Congress and got re-elected in 1948 (over a hapless Tom Dewey). Nobody reminds the President that when Truman left office his popularity was lower than Clinton's is today. Inasmuch as the President seems to need a role model and is willing to be just about anyone, the best we might suggest is John F. Kennedy. In fact, the real fight in the Democratic Party is between the Kennedy Wing and the Kennedy Wing -- the JFK wing representing risk-taking, initiative, enterprise, entrepreneurial capitalism, low marginal tax rates, a low capital gains tax and a gold standard versus the EMK wing, representing security and high taxes and security and spending and security. A JFK Clinton might even be renominated in '96, and, if he promised not to bomb anyone to bits, might even be re-elected. 

We are seeing quite a lot going on between the dust and smoke and aftershocks of the November 8 earthquake. But these four items are more or less the cornerposts that anchor us. With Alan Greenspan apparently finding a break in the clouds (see above), it's clear we're feeling pretty good these days.

Jude Wanniski