By Kim Rupert and Michael Wallace
Could this be the start of the Maestro's farewell tour? Federal Reserve Chairman Alan Greenspan returns to Capitol Hill on Feb. 16 to kick off what may well be his penultimate round of monetary-policy testimony before Congress. The Fed chief testifies first to the Senate Banking Committee that day, starting at 10 a.m. ET, with a reprise the following day before the House Committee on Financial Services.
The semiannual event always creates great excitement in the markets and financial media, but this time around, there's an added fillip. Greenspan may only appear at this venue one more time this year -- before his fifth and quite possibly final term as head of the U.S. central bank comes to a close. And just what will he say at his next-to-last Humphrey-Hawkins hurrah?
The markets will be anxiously listening for hints on the removal of the key buzzwords "accommodative" (regarding monetary policy) and "measured" (as to the pace of future rate hikes) that defined recent post-Federal Open Market Committee releases and the implications for policy. Recent gains in the Treasury market suggest Greenspan will indicate continuation of the central bank's current policy stance.
At Action Economics, we're looking for Greenspan to start setting the stage for phase II of the current policy cycle as rates move closer to neutral -- i.e., neither too accommodative nor too restrictive of economic growth. We expect him to reiterate his bullish outlook on economic growth, amid a generally benign outlook for price stability.
But there's some risk that the "measured" pace may give way if the Fed chief stresses the recent slowdown in productivity and its negative implications for inflation. Indeed, FOMC members expressed such concerns as evidenced by the minutes from its December meeting. But we suspect that was more a minority view on the committee and doubt Greenspan will emphasize that theme at his appearances before Congress.
EXPECT LITTLE CHANGE.
While the testimony is required by law, Greenspan has also used this venue to help shape market psychology. This appearance may just be one of those times. Despite some FOMC members' more hawkish leaning in the past couple of months, we don't believe the Fed chief is in a rush to quicken the pace of policy normalization. Indeed, we suspect he'll blend an upbeat assessment on the economy, an optimistic outlook on the deficits, and a sanguine view on inflation into a statement supportive of U.S. financial markets.
Other things to watch for: Will the central banker reiterate his more optimistic view (as expressed in a Feb. 4 speech in London) regarding improvement in the budget and current-account deficits? Perhaps. Social Security reform likely will be a hot-button issue as Greenspan will no doubt be pressed for his views on the topic during the question-and-answer session with lawmakers. Any statement that deviates from the chairman's previous commentary could roil financial markets.
What about the central bank's projections for economic growth and inflation issued in conjunction with the Fed chief's appearance? Expect little change in central tendency forecasts for 2005 from those set in July, 2004, including real gross domestic product growth in the 3.5% to 4% (annualized) zone and a 1.5% to 2% range for the personal consumption expenditure core chain-price index, a key inflation gauge.
As for the markets, look for cautious trading heading into the testimony, though recent gains in Treasuries and the dollar suggest investors believe that Greenspan's comments will remain on the bullish side. Treasuries could be vulnerable to confirmation of recent comments from Fed officials that the "accommodative" and "measured" language from the FOMC statements is on the way out, though a steady pace of rate hikes is largely factored in.
Quite simply, the Fed chief has a lot to cheer about and may try to instill that optimism in Wall Street. Look for Greenspan to set the stage for strong markets through 2005 as his remarkable career draws to a close.
Rupert is managing director of global fixed income analysis and Wallace is global market strategist for Action Economics