Waiting for the Fed

Greenspan expected to provide agnostic view about where policy might be headed

By Rick MacDonald

Fed Chairman Alan Greenspan returns to Capital Hill on Tuesday to give his semi-annual monetary policy report to the Senate (formerly known as the Humphrey-Hawkins testimony). His comments are expected to set the stage for the markets through the rest of the quarter.

The recent mix of stronger-than-expected data in employment and sales, along with recent comments by Fed officials that down-played recession risks, suggest the Fed may resume a more gradual path. As such, it is no surprise that MMS survey results suggest a more modest outlook. Participants still see another 50 basis point cut at the March meeting as the most likely move, but it is now a very close call -- with only 55% expecting such a move. The balance expects either a more modest 25 basis point move or no move at all. The tone of the testimony will be crucial in firming up this near-term outlook.

As for a preview of the testimony, while the chairman always manages to find some way to surprise the market. We expect the written testimony to largely be based around the three topics he always touches on: recent developments, the risks going forward and the central tendency forecasts for growth and inflation.

As for the "recent developments" section, expect him to expound on the developments that have called for such "...a rapid and forceful response of monetary policy." In fact, the press release that followed the most recent FOMC meeting may have laid the foundation for this section of his testimony, where a sharp erosion in consumer and business confidence (exacerbated by rising energy costs) was seen as the cause of the sharp retrenchment in consumer and business spending. This in turn, has resulted in the sharp cut-back in manufacturing production. We also expect him to reiterate that new technologies appear to have compressed this correction, while still playing the tune that we have so often heard -- that "longer-term advances in technology and accompanying gains in productivity, however, exhibit few signs of abating."

The "risk" assessment will likely center around the key question of whether the recent economic slowdown proves to be just a sharp, but short, inventory correction, or something more serious. On this front, it would be a huge surprise if he did not provide his usual two-handed economist disclaimer that it is "certainly premature to a make definitive assessment," giving a brief review of the reasons that support both a "v-shaped" recovery, as well as what could cause a more drawn-out trough.

Overall, Greenspan is expected to provide a rather agnostic view about where policy might be headed, leaving plenty of room for more Fed easing if necessary. He may again, however, reiterate the view that the substantial easing of rates seen already should help support the economy in the months ahead. And he may choose to reiterate the point made in the Senate Q&A session a couple weeks ago -- that a recession, by definition, is a very low probability event. This may lead to a market interpretation that he sees the most likely scenario for the economy being that bad news will be front-loaded in early 2001, which could further weight on back-end easing expectations. But as is always the case, upcoming data and financial market developments will be key.

MacDonald is a senior economist with Standard & Poor's

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