** IBD on Greenspan **
Federal Reserve Chairman Alan Greenspan took a hawkish tone before Congress on Thursday, and made another rate hike seem more likely.
Greenspan, presenting his mid-year Humphrey-Hawkins testimony to Congress, said prices remained under control. But the Fed must be ''especially alert'' to inflation risks and be prepared to ''act promptly and forcefully'' to avoid the need for more rate hikes later.
The Federal Open Market Committee moved to a neutral bias after raising interest rates a quarter-point June 30, suggesting the Fed wouldn't raise rates again soon. But Greenspan said the FOMC did not think the quarter-point hike ''would put the risks of inflation going forward completely into balance.''
He said the Fed shifted into neutral because it didn't want to signal more rate hikes were coming ''in short order.'' Policy-makers also wanted to eye more data.
''He didn't say anything new; the market just misperceived what the Fed meant by its move to a neutral bias,'' said Mickey Levy, chief economist at Bank of America in New York.
''(The neutral bias) was a huge mistake, and I think he's trying to make the best of a bad situation,'' said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y. ''He's saying whatever the bias is, the Fed is much more likely to raise rates.''
Bonds, which had rallied in recent weeks, plunged in Greenspan's wake. The 30-year Treasury bond fell 3/4 point, pushing the yield 7 basis points higher to 5.97%.
The Dow Jones industrials lost 34 points, or 0.3%. The tech-heavy Nasdaq dropped 77 points, or 2.8%.
Meanwhile, Greenspan said the federal budget surplus is very heartening. As he has said in the past, he prefers paying down the debt to tax cuts, and tax cuts to spending. Tax cuts might be useful if the economy slows, he says, but right now lower rates aren't needed to boost investment.
He said the latest budget surplus forecasts seem reasonable, but making long-term forecasts is an iffy proposition.
Greenspan made it clear the Fed does not want to see the jobless rate falling further.
''One indication that inflation risks were rising would be a tendency for labor markets to tighten further,'' he said.
But even the current 4.3% jobless rate is an inflation threat, he said. Greenspan has said in the past that the economy can safely grow 3%, with 2% productivity growth and 1% labor-force growth. But growth has been around 4% the past three years. Businesses have been drawing on an ever-shrinking pool of labor. Greenspan says that will eventually lead to rising wages - and wage-led inflation.
So far, rising productivity growth has kept inflation under wraps. But he warned the Fed can't count on that to continue.
''Should productivity fail to continue to accelerate, and demand growth persist or strengthen, the economy could overheat,'' he said.
Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson, a Chicago- based investment firm, says the Fed doesn't know if productivity growth will slow, speed up or hold steady. But he noted Greenspan stressed productivity as the key reason for the low inflation readings.
''They're clearly concerned about labor markets, but doubts about productivity should continue to keep the Fed on hold,'' he said.
Wesbury says the July jobs report on Aug. 6 will be one of the most important reports in years.
Bank of America's Levy says the jobs report won't be all-important, but says markets will be paying close attention to economic data ahead of the August meeting.
Markets will be looking for any signs that the red- hot U.S. economy is cooling. So far, the Fed doesn't see it.
The stock market's ''unwarranted, perhaps euphoric'' rise is fueling spending, Greenspan said. In June, he said the wealth effect from rising stock and home prices accounts for at least 1 percentage point of growth in recent years.
The Fed chairman said consumer spending may slow, but not much. And stronger world demand will offset some of the expected cooling in domestic demand.
Real interest rates are historically high, but June's quarter-point hike will not have much impact.
The FOMC raised its 1999 growth targets sharply. Policy-makers now say real GDP will most likely grow 3.50% to 3.75% this year, up from February predictions of 2.50% to 3%. Inflation should be a little higher, but not much: The consumer price index will probably rise between 2.25% to 2.50% in 1999.
But next year, growth should slow to around 3%, while inflation holds steady.
''If you look at the forecasts, the Fed believes growth is going to fall back to potential, and no acceleration in inflation is likely,'' Wesbury said.
Wesbury points out that May and June inflation figures were excellent, retail sales show some weakness, and exports aren't picking up yet.
But Shepherdson points out that July inflation numbers are not likely to be as positive. He says a rate hike is likely Aug. 24, when the Fed's policy-makers next meet, though it's not a done deal.
He says the Fed has only a small window of opportunity to raise rates. A rate hike near the end of the year could disrupt markets worried about the Year 2000 computer bug. |
