Will the "Maestro" Strike the Right Chord?

Greenspan's testimony this week may set the tone for the markets for months to come

By Kim Rupert

Federal Reserve Chairman Alan Greenspan makes his twice-yearly trek to Capital Hill Wednesday to testify on the economy and related monetary policy, in what was formerly known as "Humphrey-Hawkins" testimony. This will not only captivate the markets for the week, but is likely to help set the tone for months to come.

Just how the "maestro" strikes a balance between the many discordant factors impacting the current outlook will be crucial for the markets. We suspect he will be generally cautiously optimistic regarding the economic outlook. What else could he be in the face of critics who blame him for the sour notes still emanating from the economy? The markets will be watching closely to see whether Greenspan leans more in favor of a second half rebound -- or more toward concerns about another bout of economic weakness.


  What the markets will be listening for are subtle nuances regarding the degree to which Greenspan is concerned about the economy's health going forward and consequently the degree of further easing of monetary policy. Greenspan will surely nod approvingly toward the consumer sector, as it continues to show remarkable resilience in the face of serious erosion in the labor market. The still pleasant sounds coming from the housing market, along with the gains in consumer confidence will be noted too.

However, he won't be able to ignore the screeches from the emerging markets, the missed notes from other G7 economies, or the strains on Wall Street. Indeed, the recent disharmony coming from abroad threatens to reverberate back into the U.S. and potentially tip off another bout of weakness at home. That risk, rather than the fear of inflation, leaves most in the market believing Greenspan will orchestrate at least one more rate cut before he puts down the baton.


  Participants in the S&P MMS weekly survey of Fed watchers almost unanimously (91%) expect one more quarter point rate cut to a 3.50% target at the Aug. 21 meeting of the Federal Open Market Committee (FOMC), the Fed's policy-making arm, as a finale to the string of moves made this year. A smaller sampling, 24%, believe the Fed will have to ease at least once more beyond 3.50% before its task is completed. This outlook is little changed from recent weeks, although many of our contacts said that the rising instability within emerging markets, and the lack of initiative from G3 partners to stimulate their economies, increases the probability that the Fed will have to do more, and not less through the end of the year. Prospects for an intermeeting cut, though remote, were increased by the fragility of emerging markets.

With respect to the Fed's balance of risk statement, most expect the FOMC to maintain its bias toward economic weakness. Despite the insight from the May FOMC minutes of a growing dissonance over the accommodative stance, 81% of those contacted believe the threats to the recovery will keep policy makers more inclined toward an easing bias. However, a shift to neutral is expected by the November FOMC meeting.

Upcoming data won't be overly important for the market, but they could make it difficult for Greenspan to put a rosy spin on the environment. Industrial production data will be the most difficult to put in good light. The MMS Survey median shows a drop of 0.5%, not only the ninth straight decline, but still on the slide six months after the start of the Fed's easing campaign.

Rupert is a Senior Economist for Standard & Poor's Global Markets

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