A Green Light from Greenspan

When it comes to tax cuts and interest rate policy, the markets and the Fed are on the same page

By Rick MacDonald

Fed Chairman Alan Greenspan, in his testimony before the Senate on Jan. 25, gave a surprisingly ringing endorsement of tax cuts. He also warned of the peril a growing surplus poses to the economy, as it could crowd out more efficient private investment.

But he didn't spell out what the markets were looking for most: the size of the rate cut expected at the Jan. 30-31 FOMC meeting.

In the question-and-answer session that followed his testimony, the Fed chief warned that current growth was "probably very close to zero." And this could well support the view that Greenspan would not disappoint markets Wednesday by going for the more aggressive 50 basis point ease.

Overall, the message that the markets received is that Greenspan sees the economy already at ground zero, with "needed" tax cuts and monetary policy coming together as an insurance hedge against recession. And it is difficult not to agree with this assessment. While there is some risk that reports from Fed sources before the meeting may alter this outlook, our belief is that the markets and the Fed are on the same page.


  Not surprisingly, the results of the S&P weekly survey of Fed watchers suggest that Greenspan & Co. will maintain an aggressive easing course. Some 82% of the participants expect the Fed to opt for the aggressive 50 basis point move come Wednesday. And fed funds futures are even more certain of such a move, with the February contract suggesting a 95% probability.

After Super Bowl Sunday, the Treasury market will have to tackle key events and data. While the FOMC is perhaps the crucial event for the week, it could be a big non-event for the market -- especially Fed policymakers they opt for the 50 basis point easing that the market is betting on.

But as usual, any interesting spin in the post-meeting press release, or any additional insight revealed in the lagged December minutes summary on Thursday, could affect near-term policy sentiment.


  Other events on the calendar include Monday's announcement by the Treasury of its estimates for Q1 and Q2 borrowing needs and Wednesday's refunding details. Data highlights include consumer confidence (this will be closely watched after Greenspan noted some concern about spending), Q4 GDP, NAPM, unit auto sales, and payrolls.

The Fed's action on Wednesday, along with the tone of the press release that follows the meeting, may lead to speculation on the degree of weakness that will be seen in the NAPM and employment data, as the Fed likely will have had an early peek.

MacDonald is a senior economist with Standard & Poor's

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