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Strategies & Market Trends : VOLTAIRE'S PORCH-MODERATED -- Ignore unavailable to you. Want to Upgrade?

To: Dealer who wrote (22358)	12/6/2000 11:06:06 AM
From: Dealer	Respond to of 65232

United States: Shifting Gears David Greenlaw (New York) Fed Chairman Greenspan's speech on Tuesday to a group of bankers in New York signaled that the FOMC is prepared to shift to a neutral bias at the upcoming December meeting. As highlighted in our Daily Preview, it appears that Greenspan was indeed aiming to reinforce the smoke signal that appeared in Jake Schlesinger's piece in Monday's Wall Street Journal (as well as a subsequent article by Steve Beckner of Market News). The key passage in Greenspan's address was the following: "... In an economy that already has lost some momentum, one must remain alert to the possibility that greater caution and weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending." While Greenspan placed some emphasis on the downside risks, we don't get the sense that he is looking to trigger an outright ease right away. For example, the Fed chief indicated that "our current circumstances are in no way comparable to those of 1998. Financial markets continue to function reasonably well and credit continues to flow." Moreover, Greenspan said the economy is still in the process of transitioning "to a more sustainable balance in growth of demand and supply." This is consistent with our view that the Fed is in reactive mode. While there would eventually be a response from the Fed if the economy slows too much, there is little incentive to act preemptively. Why risk reinflation just as the long-awaited soft landing scenario could be on the verge of playing out? The financial markets' response to Greenspan's speech highlighted the Fed's dilemma. An important component of the soft landing goal is a cooling of the so-called wealth effect. But in the aftermath of Tuesday's rally, the Wilshire 5000 has now recovered about 6 percentage points of the 15% year-to-date decline that had been evident less than a week ago. By our estimates, this still implies a significant evaporation of the wealth effect -- a development that is already contributing to a moderation in consumer demand. However, the trend could prove to be temporary if the stock market continues to rally. Another key factor that has been cited as a contributor to some downside risk for the economy is the reduction in credit availability. But corporate issuance appears to be picking up and credit spreads are narrowing. Indeed, while the swaps market would normally be expected to underperform when there is a big Treasury rally like the one that occurred on Tuesday, spreads actually tightened by 2 to 3 basis points on the day. The bottom line is that the Fed is prepared to shift its policy gear into neutral but it's unlikely they will step on the accelerator until March at the very earliest -- especially if the financial markets are able to hold onto recent gains.