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Greenspan Puts on a Happier Face

By Michael Wallace Federal Reserve Board Chairman Alan Greenspan on Jan. 24 took the opportunity to soothe some jangled nerves on Wall Street. Speaking before the Senate Banking Committee, Greenspan in his prepared text covered much of the same ground as the Jan. 11 speech in San Francisco that investors interpreted as rather pessimistic on the economic outlook. This go-round, the Fed chief lightened up a bit about risks to future growth.

During the question-and-answer session following the testimony, Greenspan said he tried to make the point on Jan. 11 that the economy "was stabilizing" and that he "should have phrased the speech differently." Yet he said didn't want to overstate the case for recovery, as he believed the markets were "assuming a more rapid snap-back than likely."

There were no remarks on Jan. 24 like his Jan. 11 comment that "it is still premature to conclude that the forces restraining economic activity here and abroad have abated enough to allow a steady recovery to take hold." This time around, although he said fourth-quarter gross domestic product growth was likely flat, the Fed chief suggested the business cycle is at a turning point.

STANDING PAT. Although it may be premature to abandon the bias toward easing interest rates that the Fed currently has in place, it sure seems as though the more Greenspan speaks, the less likely a short-term rate cut appears when Fed policymakers meet Jan. 29-30 for their first session of 2002. Standard & Poor's/MMS International expects the Fed Open Market Committee to hold rates unchanged.

And Wall Street seems to concur. The current February contract for federal fund futures, a traded instrument investors use to bet on the direction of short-term interest rates, rapidly slashed odds of a quarter-point cut next week, to 10%, from 18% a day earlier. Also, the deferred contracts are pricing in a higher probability of a quarter-point rate hike as soon as early May. The June contract had priced in only a 36% risk of a May 7 hike on Jan. 23, but that nearly doubled to 60% on Jan. 24.

Greenspan does remain cautious on household income and spending, but he spoke more brightly about "some abatement in the rate of job loss." He also said auto sales remain surprisingly resilient after recent financing incentives tapered off and that plunging energy costs, warmer weather, and the strong housing sector are supportive of an economic rebound.

NO PRICING POWER. This fits with much of the recent Fedspeak of other central-bank officials, who had been taking a cautious line on the pace of the recovery and its timing, but not its likely arrival. Greenspan also said the 2001 tax cuts helped mitigate the recession and declined to comment on the U.S. dollar, deferring to the Treasury Dept.

One area Greenspan still has concerns about is the strength of business spending, given "the virtual absence of pricing power across much of American business." He warns that profit margins are still under pressure and that businesses are reacting by slashing costs [employees] in order to preserve "the vast majority of private-sector jobs." Longer term, he repeated his belief that the spread of supply-chain technologies is a plus for steadier growth and productivity gains.

The Fed chairman also said recovery will probably occur whether or not Congress and the White House can agree on a stimulus package in the near term and that additional fiscal stimulus may not be necessary, although it's conceivable the economy may still need a push. It was hardly a ringing endorsement for President Bush's stimulus proposal and gives the Democrats an opening to exploit, particularly in the wake of the budget surplus reversal predicted by the Congressional Budget Office and the Office of Management & Budget.

WORTHLESS FORECASTS. Greenspan recommended that a budget trigger be instituted to limit tax and spending initiatives in the future. Still, he mostly sang from the same hymnbook as the Bush Administration, saying fundamental fiscal trends are favorable. "Despite the erosion in the budget picture over the past year, our underlying fiscal situation today remains considerably stronger than that of a decade ago, when policymakers were struggling to rein in chronic deficits," he said.

As in the past, though, the Fed chief warned that long-term forecasts are about as good as the paper they're written on. And he warned that the demographics after 2010, as more and more baby boomers reach retirement age, are fiscally significant and that productivity growth will be the key to sustaining economic growth in that era.

On the issue that is enveloping most of Congress in recent days, Greenspan implied that the Enron debacle would not cause systemic problems for the broader economy. Instead, he said it actually shows the economy's ability to absorb such a huge bankruptcy. Investors and Congress won't have long to wait until they hear from Greenspan again. He'll deliver his semiannual report to Congress in a few weeks. Wallace is a market economist for Standard & Poor's/MMS International in San Francisco

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