If you think Washington is hopelessly broken or that the Federal Reserve is bitterly divided between hawks and doves, you’re wrong, according to Greg Valliere. These were two of six common assertions Valliere challenged in a talk last week.
Valliere is the chief political strategist for the Potomac Research Group, a DC-based political consulting firm. He spoke to an audience of 200 at FundForum USA in Boston on October 28. Valliere prefaced his remarks by positioning himself on the 50-yard line, not promoting the left, right or any specific political ideology.
Myth 1: Washington is hopelessly broken
Valliere acknowledged that Washington was broken in 2013 and cited the political debacles of the government shut down and the debt-ceiling crisis. Valliere said that those experiences were unnerving to a Congress with plummeting job approval ratings. So unnerving, in fact, Congress was moved to act differently in 2014 and achieved positive gains in a number of areas.
They passed a two-year budget with a bipartisan effort led by conservative Paul Ryan (R-WI) and liberal Patty Murray (D-WA). Congress reached a deal on the debt ceiling led by Speaker John Boehner (R-OH). They passed a bipartisan farm bill and a VA reform bill. They guaranteed there would be no government shutdown with the new fiscal year starting on October 1. Lastly, Congress and the White House worked together with Boehner to get 159 Republican members of Congress to vote with the president for arming Syrian rebels.
In 2014, Valliere said the economic results were impressive with GDP growing at least 3%, inflation virtually nonexistent, and unemployment and the deficit both falling. Valliere concluded that while “[t]here are many members of Congress who act like idiots and many federal agencies that are dysfunctional, the facts of 2014 refute that Washington is broken.”
Myth 2: The Federal Reserve is hopelessly divided between hawks and doves
This is the most monolithic and dovish Federal Reserve Valliere has seen in his lifetime. He said this Fed will become even more dovish and unified as the dissenting hawks, who do not favor the policies, leave. Jeremy Stein returns to Harvard and Charles Plosser and Richard Fisher are retiring. This leaves Esther George as the remaining hawk.
One unifying mantra of this Fed, Valliere said, is “that if they err, they err on the side of staying a little too easy for a little too long rather than erring on the side of tightening too soon.” He noted that, with rates this low, if the Fed tightens too soon it is hard to fix. If they wait a little too long, they “can always tap on the brakes to cool off the economy.”
The second mantra Valliere says is that there are more downside risks than upside risks to the economy. Although GDP increased at a rate of 3.5% in the third quarter of 2014, the Fed foresees downside headwinds from Germany, China, an “unhealed” U.S. labor market, and an inflation rate that is “still too low.” With quantitative easing (QE) ending on October 29, Valliere predicted the Fed will wait until as late as next summer before raising rates. It will be a very slow process where the Fed will ensure these rate hikes do not negatively affect the economy.
Myth 3: We’ve made progress on the deficit and we don’t need to worry
Valliere is unwilling “to declare a victory over the deficit” because of looming entitlements costs and the pendulum shifting away from fiscal restraint. Valliere is pleased that we have made “dramatic and astonishing progress” on the budget deficit, which is currently 2.8% of GDP and below its 40-year average of 3%. He predicted that the deficit will come down to 2% of GDP in the next three years.
“The numbers that were the most astonishing in the year that just ended were that outlay spending in the U.S. rose by 1% and receipts rose by 9%,” he said. Valliere predicted that these trends will persist, but he is unwilling to be self-congratulatory. The government is reluctant to tackle social security and Medicare “which will eat us alive in the next decade,” he said. He added that, out of fear of risking re-election, “No one in either political party has the courage to go after entitlements.” In addition, Valliere sees fiscal restraint falling out of favor, noting “a growing malaise.” He predicted politicians will disregard budget sequestering in favor of Pentagon-related spending, which he believes will position the U.S. defense sector as an attractive investment.
Myth 4: Republicans will be resurgent and dominant after November’s elections
Valliere thinks Republicans will dominate the November elections, Valliere predicted, because presidential administrations historically do poorly in their sixth year. He listed a number of negative public perceptions of the government, including its handling of ISIS, Ebola, Obamacare, and even allowing intruders into the White House.
He believes that the Democrats, “will take a beating” and the Republicans will gain up to 10 additional seats in the House. Furthermore the House will remain Republican at least through 2021 after the next redistricting takes place. Valliere predicted the Republicans will gain seven or eight Democratic seats to take control of the Senate. He said that Republicans will have a private post-election caucus to debate how to proceed; the Tea Party faction led by Ted Cruz will call for strikes, confrontation and shut downs, but the more pragmatic Mitch McConnell and John Boehner will override them.
Valliere said this pragmatism will be good for the financial markets. Republicans will try to veto Obamacare, but will fail. Republicans have a good chance to modify Obamacare by eliminating the medical-device excise tax, he said, which is also unpopular with Democrats. Republicans will try to move through the Keystone pipeline but will be thwarted by the president’s veto power.
The Republicans, he said, will move legislation around exporting crude oil and liquefied natural gas forward with popular support. The biggest issue facing Republicans next year will be tax reform, he predicted, particularly corporate tax reform as that is the “low hanging fruit.” Valliere pointed out that there is something wrong with the U.S. tax code when companies like Burger King try to move to Canada as a tax haven. Valliere thinks Paul Ryan will move quickly on these legislative tax issues, and the U.S. markets will benefit from these repatriated earnings. He does not foresee progress on individual tax reform because of the strong support for tax breaks for municipal bonds, mortgage deductions and charitable giving.
Valliere said the Republicans will try to show they can lead next year, but will have to concede the 2016 presidency to Hillary Clinton because the electoral demographics favor females, minorities and younger voters. Furthermore Republicans can’t win by, “being addicted to nominating old white men.” Valliere predicted Hillary will have the enthusiasm to run because “the bench for the Democrats is very thin after her.” Joe Biden is making, “one spectacular gaff after another.” Elizabeth Warren is unable to win a national election, and scandal-plagued Andrew Cuomo is in free fall.
The Carl Rove Republican establishment camp thought they had a candidate in Chris Christie, Valliere said, but Bridgegate, New Jersey’s problematic credit rating and a history of not nominating liberal republicans from the northeast will prevent his nomination. Valliere predicted they will go with Jeb Bush despite problems with conservative activists, his wife’s strong dislike of politics and his daughter’s substance abuse history.
Myth 5: If Hillary wins, it will be bad for the markets
Valliere offered three reasons why the markets do not have to worry about a Hillary Clinton administration. A Republican House will act as a checkmate to her presidential authority. Hillary is “far more moderate” than Obama on all policy issues and he said she would consider a Keystone deal and a deficit deal. Third, while Elizabeth Warren supporters and others might call her a “crony capitalist” because she talks to Robert Rubin and Larry Summers, Valliere argued that this is a positive. He said the Obama administration would have done better with more ties to Wall Street.
Valliere said the markets would have to worry about a Rand Paul presidency, however, because of his antipathy for the Federal Reserve and his isolationist policies.
Myth 6: Geopolitical events do not rock markets in U.S.
Valliere noted that this myth has been “demolished” in the last six weeks, as geopolitical events have driven changes in the price of oil, the volatility of the stock market and the continued belief that Treasury bonds are the ultimate safe haven. Current geopolitical problems with ISIS, Putin, Hong Kong and Iran will continue to rock the markets, he said.
With regard to ISIS, Valliere’s Pentagon sources predict the U.S. could not have boots on the ground until spring although continued air strikes should hold Baghdad. Nevertheless, ISIS now controls Anbar Province and he sees the chances of deploying combat troops as negligible.
Valliere said he would be surprised if Putin did more in Eastern Ukraine, but predicted he will further manipulate the Ukraine through Russian control of the natural gas supply. Putin’s bigger goal will be to stir up trouble, he said, using large Russian-speaking minorities in Latvia, Lithuania, Estonia, and Belarus to make those countries less secure. Valliere predicted this will lead to “continuation and intensification” of sanctions against Russia, which will hurt an already teetering Western Europe economy.
With regard to Hong Kong, Valliere’s fear is that the problem could end up with another Tiananmen Square outcome if Beijing tries to quiet all Hong Kong dissidents.
With regard to Iran, Valliere worries about the November 24 deadline for Iranian nuclear talks. He said both sides are “hopelessly deadlocked and miles apart” on uranium enrichment and this will lead to more sanctions against the Iranians and those who trade with Iran.
Justin Kermond is the vice president of business development for Advisor Perspectives.
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