One more chance for Greenspan
If markets read him wrong, he'll tell us so
By Rex Nutting, CBS.MarketWatch.com
Last Update: 6:41 PM ET Jan. 18, 2002
WASHINGTON (CBS.MW) -- Investors are hanging on Alan Greenspan's every word again.
For the second time in three weeks, public remarks by Federal Reserve Chairman Alan Greenspan will dominate discussions about the economy.
Greenspan is scheduled to testify at the Senate Budget Committee on Thursday. He'll certainly be asked for his views on monetary as well as fiscal policy.
The remarks Greenspan made on Jan. 11 were instrumental in a marked but temporary transformation in perceptions about what the Fed would do next.
Greenspan gave a very balanced view of the economy in his last speech, a surprise to many market participants who had made up their minds about where interest rates were going and how fast. Greenspan's speech added some uncertainty to those calculations.
In his speech, Greenspan said the economy was getting better -- or at least no worse -- but he also warned that "significant risks" remain. See full story.
Greenspan's caution shocked the markets. Futures markets began pricing in another rate cut on Jan. 30 and bonds rallied modestly on the new expectation that the Fed's eventual move toward higher rates might be farther away than folks had thought.
Whenever the market reacts decisively to an indecisive Greenspan, there's always a danger that he'll have to herd the market back the other way the next time he speaks.
"It will be interesting to see if Greenspan alters his perspective," said David Orr, chief U.S. economist at Wachovia Securities.
Smoke or signals?
In the past week, the herd's expectations about the Fed drifted back close to where they were before he spoke. The markets were reacting in large measure to the recent robust economic data. In addition, the Fed itself seemed to be sending out "clarifications" about Greenspan's true feelings.
"The Federal Reserve appears to be deliberately trying to signal ... that Greenspan did not intend for his latest speech to be read as ... pessimistic," wrote Tony Crescenzi in his widely followed market notes for Miller Tabak.
Crescenzi pointed to several clues that the Fed was sending a signal, including the fact that Greenspan's old friend and current colleague, Treasury Secretary Paul O'Neill, came right out and said Greenspan had been misinterpreted.
Greenspan is "probably a little surprised that everyone read negative when the intention was more neutral to up," O'Neill said on an interview on CNBC. Later, O'Neill told Charlie Rose that Greenspan's "next task will be to decide when he should raise interest rates rather than lower them."
Insiders at the Fed apparently have also been leaking the same message to Wall Street consultants and favored Fed reporters. And other members of the Federal Open Market Committee, like Tony Santomero of the Philly Fed and Michael Moskow of Chicago, kept up the chant that the recovery is right around the corner.
We must bear in mind that everyone involved here has a reason for spinning Greenspan's words one way or the other, including Greenspan himself.
Sustained recovery
Remember, the goal of Greenspan and others on the Fed isn't to achieve any particular fed funds rate at any particular time. They don't know or care what the fed funds rate will be on June 30. The Fed wants to ensure a sustained recovery, that's all.
But market participants do care what the fed funds rate will be. Every investment decision must be made in the context of the Fed's interest rate policies.
That's what makes Greenspan's job so difficult. He'd prefer to let the markets drive the recovery, but that would require lower long-term rates in the bond market, but not lower stock prices.
MarketWatch.com's chief economist Irwin Kellner complained in his column on this site that Greenspan's words were threatening to stall the recovery by introducing too much pessimism into the stock market. Read Kellner's column.
Greenspan doesn't want to drive the stock market lower by any means, but he does want to introduce a little pessimism into the bond markets. After all, yields had soared in the past two months, putting a dent in mortgage refinancing activity that had been a major source of additional funds for consumers.
Corporate borrowing, too, is threatened by higher yields.
"It doesn't help that the bond market takes away all their easing," said Diane Swonk, chief economist at Bank One.
Long-term rates had probably gone too high, considering how fragile the recovery is. Greenspan has succeeded in getting bond traders to reconsider their expectations of a full percentage point of Fed tightening in the next six months.
Many economists have been counseling their clients that the Fed probably won't be aggressive about raising rates once they see economic stability.
"Market expectations notwithstanding, since the large and complex U.S. economy does not turn on a dime, neither will the Fed, said Wayne Ayers, chief economist at FleetBoston.
"We think there is a good chance the Fed will not raise short-term rates all year," said Wachovia's Orr.
The data
The economic calendar in the coming week is light ahead of the Fed's Jan. 30 meeting. Only three monthly indicators are on the schedule, none of them typically move markets.
On Tuesday, the Conference Board releases its December index of economic indicators. The leading index, which is supposed to forecast turning points, will be up strongly. The data are due out Tuesday at 10 a.m.
The consensus of economists surveyed by CBS.MarketWatch.com is for the index to rise 0.8 percent, with a large risk to the upside. Since the board changed the way the index is figured, economists have been underestimating it consistently.
"We look for the index to advance 1.5 percent in the month, its single largest advance since early 1983," said Lehman Brothers economists Ethan Harris and Stephen Slifer in their weekly notes.
On Friday at 10 a.m., the National Association of Realtors reports on December existing home sales. Economists expect a drop in the annualized rate to 5.17 million from 5.21 million in November.
The Treasury Department will report on December's federal budget balance on Tuesday. The Congressional Budget Office estimates that the surplus fell to $24 billion from $33 billion last December.
The weekly indicators will continue to get lots of attention, especially first-time jobless claims on Thursday morning. Economists expect a slight increase to about 393,000 from 384,000 in the previous week. Another number below 400,000 would continue to point to stability in the job market.
Economists are looking for declines of just 54,000 in payrolls in December, but those estimates will be reduced if the initial and continuing claims numbers continue to fall. The monthly report is derived from a survey taken that week.
Rex Nutting is Washington bureau chief of CBS.MarketWatch.com.
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