From Rob Black's Market Wrap:
In his March 2 remarks to the Economic Club of New York, Chairman Greenspan showed interest in the value of the dollar. “Central bankers have a primary goal to protect the value of the currency. We, as a first order of business, ask ourselves, are rates too low? The burden of proof is on the issue of rates being too low.”
In the Q&A, he agreed with the statement that a 1% interest rate in a 6% growth environment is “way too low.” “The current federal funds rate is accommodative, and, at some point, it will have to rise back to a more neutral state, because it is inconsistent with general long-term stability. This is a very special case that we're dealing with.”
Greenspan corrected the impression that he might think floating-rate mortgages make sense in today’s environment (which would imply that he doesn’t think interest rates will rise much). “That's not what I meant… I thought I was talking about a very small segment of households. I always took a long-term mortgage. I thought that the price that you had to pay – which is significant, because we are dealing with an upward-sloping yield curve -- that it was a sort of “gimme putt” for golfers.”
In his speech to the credit union association, he explained that the consumer has a strong balance sheet (strongly implying to us that a rate hike would not be disruptive): “Overall, the household sector seems to be in good shape, and much of the apparent increase in the household sector's debt ratios over the past decade reflects factors that do not suggest increasing household financial stress. And, in fact, during the past two years, debt service ratios have been stable.”
The Fed chairman suggested that Japan’s economy is strengthening to the point where it may have to reduce its monetary stimulus. We think a stronger Japanese economy has positive implications for the U.S. economy and U.S. interest rates:
“The current performance of the Japanese economy suggests that we are getting closer to the point where continued intervention at the present scale will no longer meet the monetary policy needs of Japan.”
Greenspan raised a caution flag over the monetary stimulus in China and the risk of overheating. The free-lunch situation in China also reflects on U.S. monetary stimulus because of the linkage between currencies, commodity prices, and interest rates: “Chinese central bank purchases of dollars, unless offset, threaten an excess of so-called high-powered money expansion and a consequent overheating of the Chinese economy. The Chinese central bank last year offset --that is, sterilized-- much of its heavy dollar purchases by reducing its loans to commercial banks, by selling bonds, and by increasing reserve requirements. But the ratio of the money supply to the monetary base in China has been rising steadily for a number of years as financial efficiency improves. Thus the modest rise that has occurred in currency and commercial bank reserves has been enough to support a twelve-month growth of the M2 money supply in the neighborhood of 20 percent through 2003 and a bit less so far this year. Should this pattern continue, the central bank will be confronted with the choice of curtailing its purchases of dollar assets or facing an overheated economy with the associated economic instabilities. Lesser dollar purchases presumably would allow the renminbi, at least temporarily, to appreciate against the dollar.”
The market is seeing increasing signs that price increases are spreading through the U.S. economy. The year-over-year PCE inflation rate rose to 1.5% in January from 1.3% in December. It is already at the very high end of the Fed's forecast range for 2004. The Institute of Supply Management data on prices paid shows that prices are rising more broadly now than when the Fed started raising interest rates in February 1994. The recent decline in U.S. bond yields is, more of a 1993-style capitulation phenomenon than an indicator of an economic slowdown.In 1993, bond yields reached their lows in mid-October, just three-and-a-half months before the 1994 rate hikes started, and showed almost no anticipation of the rate hikes. |
