Predictions 2011: Greg Valliere On The Markets And Washington

1. The Federal Reserve ends its QE2 program in June.

Responding to intense political criticism and an improving economy, the central bank ends its highly controversial monetary-policy program after purchasing Treasuriesin June. The Fed will avoid punitive legislation (getting 60 votes in the Senate for anything will be virtually impossible in 2011), and GDP growthof nearly 3 percent next year will ease pressure on the central bankers. By year-end, speculation will be percolating about the first Fed rate hike, which could come in early 2012.

2. The markets will receive a mighty scare in May.

That's when the debt ceiling of $14.4 trillion will be hit. Conservative activists in Congress, led by Tea Party zealots, will refuse to raise the ceiling without savage spending cuts, some of which President Obama will reluctantly aaccept. The government will continue to operate, but it will be a very close call in May—rattling the bondand currency markets. Meanwhile, the mood of austerity will intensify on both the state and federal levels, and the Federal deficit will begin to fall because of spending restraint and improving revenue

3. Over a dozen challengers will announce for the presidency.

This will include one or two Democrats, probably on the left, who will oppose Obama’s policies on Afghanistan, taxes, and you name it. The GOP fight will heat up between the moderates, headed by Mitt Romney, and the zealots, led by Sarah Palin. A compromise candidate will begin to emerge by late 2011—Tim Pawlenty, the squeaky clean, bland conservative governor from Minnesota, who will become the favorite to win the Iowa caucuses.

4. Gridlock will prevail in Washington.

President Obama will use his veto pen frequently, and his regulatory agencies will continue to pursue activist policies, but the political climate will be a plus for investors (for a change). Meanwhile, the drumbeat will grow louder for major reform of entitlements and taxes. Who can make sense of the baffling corporate and individual tax code? Whichever party makes progress on this issue will have a leg up in 2012.

5. Geopolitics will be the great wild card.

Anxiety over Iran’s nuclear ambitions will continue to grow during 2011, as intelligence agencies conclude that a computer worm (probably planted by Israel) will not be sufficient to stop Tehran from acquiring a dirty nuclear bomb by the end of the year. This will greatly intensify Mideast tensions, as speculation grows that an Israeli strike on the nuclear facilities may become inevitable.