Is it time to clean out the money market funds before the inevitable???
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Greenspan Has Opportunity To Clarify the Fed's Message
In Report, Chairman Has to Balance Optimism With Stance on Rate Cuts
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- Federal Reserve Chairman Alan Greenspan has a delicate job ahead as he delivers his twice-yearly monetary-policy report to Congress Tuesday and Wednesday. He needs to sound optimistic on the economy while making it clear that the Fed won't raise interest rates soon and will cut them if necessary.
His testimony will give him a chance to clarify a message that many critics say was fumbled at the Fed's June 25 meeting. The Fed cut its target for the federal-funds rate, charged on overnight loans between banks, by a quarter percentage point to 1% -- less than the one-half percentage point many investors expected. At that time, the Fed said the risk that inflation could fall too low would "predominate" its thinking for the "foreseeable future," but it also cited signs of "stabilizing" economic activity.
The stock market got the optimistic part of the message; it is roughly unchanged since then. But bond investors were disappointed the Fed didn't cut rates more or announce unconventional policies for boosting growth, such as buying bonds. They dumped bonds, and the 10-year Treasury yield, which moves in the opposite direction to price, has since risen to 3.65% from 3.25%.
Bond yields fell sharply after the Fed's May 6 acknowledgement that it was worried about inflation falling too far, and Fed officials had expected some rise in yields after the June 25 meeting. But many were surprised by the magnitude. Rising yields threaten to push up mortgage rates, threatening mortgage refinancing and home buying, important props for the economy.
Only Robert Parry, president of the Federal Reserve Bank of San Francisco, dissented in favor of a half-point cut. Other Fed officials also saw merit in such a move, but the majority went along with Mr. Greenspan and settled for the smaller cut. Given some positive economic signals, Fed officials worried that a half-point cut might convey too much pessimism, panicking stock investors. A half-point cut also might have suggested to investors that the Fed was done with its rate-cutting, which might have pushed up bond yields even more.
The debate will be moot if the economy picks up. Mr. Greenspan probably will tell Congress growth should accelerate in coming months. He remains more optimistic than many of his colleagues and likely will cite scattered evidence of the postwar pickup he long has expected, while acknowledging hard evidence is scarce. He may emphasize that there is so much unemployment and unused capacity in the economy that inflation remains likely to edge lower.
Markets also will look to Mr. Greenspan for hints about the Fed's views on unconventional monetary policy, given that short-term interest rates are at a 45-year low. They may not get much. While Fed policy makers discussed these options at length at their June meeting, there is no sign they have emerged with any consensus. Mr. Greenspan himself appears uneasy about the unpredictable consequences of unconventional policies, whether buying bonds or committing to hold down the funds rate for a particular period of time or until some economic target is met.
Mr. Greenspan, however, could reassure the public that the Fed has plenty of room for conventional stimulus. He has noted that cutting the funds rate closer to zero creates difficulties in the financial system -- such as depriving money-market funds of the ability to cover their expenses. But Fed officials are coming to believe such problems in the financial system would be an acceptable price for additional stimulus, and Mr. Greenspan may debunk the notion that the Fed won't cut the federal-funds rate below 0.75% or 0.5%.
Write to Greg Ip at greg.ip@wsj.com
Updated July 14, 2003
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