Can Washington Deliver?

With the economic calendar relatively on the thin side in this holiday-shortened week, the market is keenly waiting for the two speeches from Washington this Thursday—the first by Fed Chair Ben Bernanke and the second by the President Obama, focused on the labor market. Given the relatively low expectations, particularly from the president, there is room for positive surprise.

Reports in the media indicate that the president plans to announce a roughly $300 billion program that will include a mix of tax incentives and spending through an infrastructure bank. On the tax front, the president will likely ask for an extension of the payroll-tax holiday that expires at the end of this year. Another tax measure could be a job-centric tax credit for employers. Another idea floating around is to offer a temporary holiday for repatriation of corporate cash parked overseas at present. Given the anti-spending mood in Congress, the president is expected to suggest paying for these upfront outlays with cuts in the outer years.

There is a lot less ambiguity about what the Fed could or should do in response to the recent run of soft economic reports. The minutes of the last FOMC meeting provides plenty of evidence that the committee has considered further easing as a viable policy option. However, given dissensions within the FOMC, the Fed is unlikely to announce a new bond purchase program along the lines of the last quantitative easing program.

A more viable alternative appears to be the repositioning of the Fed's bond portfolio towards longer-maturity bonds. This would involve using proceeds from maturing bonds, obviating the need for increasing the size of the Fed balance sheet. The goal will be to trigger a mortgage refinancing cycle by bringing down long-term interest rates.

With yields on 10-year Treasuries at the under-2% record level and a big chunk of current mortgages under water, it is far from certain that this move will have the desired effect. But given the pressure 'to do something,' Bernanke may tip his hand on this front in his Thursday speech.

The policy response from Washington may help on the margin, but there are no silver bullets here. The problems facing the U.S. economy are more structural and long-term in nature and generally outside the purview of the Fed. In the absence of cooperative and creative leadership from the executive and legislative branches, it is difficult to envision anything substantial at this stage. This is particularly so after what we saw in the debt-ceiling debate. -Zacks Investment Research