Wednesday, November 3, 2010

GOP gains: Good for hawks, bad for doves

The GOP midterm gains should be positive for equities because they increase the probability that taxes on dividends and capital gains won’t be raised in January. However, this silver lining also comes with a cloud: Tea Party antipathy to the Fed and “inflation”.

To the extent that Congress decides to award itself a seat on the FOMC, there will be even greater pressures against unconventional anti-deflationary policies. This is not good for equities.

To understand the way that central bankers think about public opinion, this is what Governor Kevin Warsh said recently:
“The Fed's institutional credibility is its most valuable asset, far more consequential to macroeconomic performance than its holdings of long-term Treasury securities or agency securities. That credibility could be meaningfully undermined if we were to take actions that were unlikely to yield clear and significant benefits.”

In other words, millions of unemployed parents is unfortunate, but “institutional credibility” more important. Just ask the BoJ.

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