The Daily Interview: Miller Tabak's Tony Crescenzi

So, does Alan Greenspan have any surprises for the market?

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That's the question of this week, and it's worth a good deal more than $64,000 to Wall Street. One Fed watcher -- Tony Crescenzi, chief bond strategist at Miller Tabak -- thinks the grand pooh-bah has done little to counter the widely held belief that a 50 basis-point rate cut is in the offing. And given that the Street doesn't like surprises on the downside from the Fed , Crescenzi thinks that estimate looks pretty solid.

For Crescenzi -- who also runs and writes commentary for Bondtalk.com, which provides daily updates on the fixed-income market -- the questions going forward are how much more the Fed will cut, and how the markets will respond. To hear the answers, read on.

TSC: What do you expect the Federal Reserve to do tomorrow?

Crescenzi: I think about it this way. When Greenspan spoke Thursday, 90% of the market expected a 50 basis-point rate cut. He knew that, we can assume, and he did little to dispel the notion of a 50 basis-point rate cut. One-hundred percent of primary dealers expect a 50-point cut. I can hardly remember a time when the Fed went against the universal view on the Street, especially with negative surprises. I can remember positive surprises, when they cut when no one was expecting it. But to surprise the market with less of a rate cut would be a problem. So 50 is a highly likely scenario; there's an outside chance of 25, but if that's the case he made an error last week. So 50 is the call right now.

It doesn't necessarily mean the bond market is going to do well. Since January, the yields bottomed. The low [in the market] for the year, and in the bond, was a day before the [Jan. 3] rate cut. Some people get puzzled by that -- how are rates lower the day before they cut rates? Because markets are discounting machines, and in this case they're anticipating right in that they're looking for more rate cuts. We might get more "buy the rumor, sell the fact" behavior. (A good example was last May. The peak in yields was the day of the last hike.)

Financial conditions have loosened up considerably. M3 [a measure of money supply , calculated by the Federal Reserve] is up $215 billion in eight weeks; that's a 21% rate of increase. It signifies increased liquidity, partially because of big jumps of institutional money markets and CDs. You could argue that it represents defensive posturing.

Part of [M3] is CDs created by banks to offset increased lending activity. The loans are assets on their books. There's evidence of a big increase in real estate loans, mortgage refinancing, and commercial and industrial loans have gone up considerably. It's very noteworthy. Also, there's corporate bond issuance. That money's going to be funneled into the economy at some point. They're not borrowing money to put it in the bank -- they're borrowing for future expenditures. That's very important, and between that and the 20% run-up in the Nasdaq , the mortgage refinancing up fourfold in a month, we're liquefying again. The liquefying going on and that spells improvement in the economy. It looks to me that the economy stopped contracting in January -- looking at jobless claims, auto sales, and store sales. We may have seen the abyss of the slowdown.

TSC: How much easing do you expect from the Federal Reserve, ultimately?

Crescenzi: Given the developments in financial conditions and the economy, there's a decreasing scope for more rate cuts. The market's priced for about as much as it can get. By year-end it's priced for about a 4.75% to 5% fed funds rate , which is a decline of about 100 to 125 basis points more. Right now, the way things are headed, with the improvement in January -- which is so tentative and too early to say much about -- if it continues, that 100 to 125 may be all that's needed. I just see what's going on in January. Tax cuts are on the way, and Americans spend every penny they're given.

TSC: The manufacturing indices have been very weak. What's your assessment of the state of the economy?

Crescenzi: One thing is that many of these indices reflect on manufacturing activity and not demand. The production side always catches up. If car sales picked up for a month or two, it's unlikely Ford, General Motors and Chrysler would pick up production significantly -- they would risk overproducing and hurt their profits. Demand will outstrip production for a while. The Chicago, Philadelphia and NAPM [indices] will be weak, but when inventory gets drawn down because of high sales, production will increase. The demand side picks up and then production explodes at some point. It's the opposite of last year, when spending fell first and production cratered, demand came in hard; inventories rose sharply.

TSC: How do you think the markets will react, and will the focus continue to be on more rate cuts, or other issues?

Crescenzi: We're going to follow the economic numbers. The Fed is getting close to entering the watchful waiting period where they sit back and absorb what they've done. And the market will do the same, and see, what is the degree of response to the rate cut. The compression of yield spreads -- is the high-yield market doing well, and all the other things I've mentioned -- we'll be watching the degree of responsiveness.

The Fed's going to get close to that period. Right now, they're in a very proactive mode, but they'll depart from that mode. Because 100 basis points in the month -- that's the first time since November 1984. By moving 100, if they do, it's to catch up, in a sense, with the economic realties. There's a limit to how proactive the Fed will be.

The Greenspan Fed prefers gradualism. They prefer to take stock and look for signs of economic impact. They're going to be quick to respond, they're ready to respond decisively to economic weakness, that's what they should be doing, but they're going to want to wait to see those signs.

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