David A. Gaffen

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Greenspan Shrugged: The Fed's Support Role Is Nearly Finished

David Gaffen

The equity market has a love-hate relationship with Fed Chairman Alan Greenspan , depending on what kind of lip service it's getting. Today, Greenspan's eagerly awaited comments provoke neither love nor hate, rather a general dislike.

The chairman, currently answering questions following his delivery of the Federal Reserve's semiannual assessment on monetary policy and the economic outlook before Congress, had only one zinger in his typically careful, well-measured comments. In his speech, he suggested that despite further expected weakness in the economy, the Fed is nearly finished, if not completely finished, cutting interest rates for now.

"Certainly, should conditions warrant, we may need to ease further, but we must not lose sight of the prerequisite of longer-run price stability for realizing the economy's full growth potential over time," Greenspan said.

It's a message that equity folks don't seem to like, although it's hard to imagine how they could be surprised by it, given the Fed's aggressive rate-cutting. Nevertheless, the Dow Jones Industrial Average , down about 26 points at the time of the speech's release, was off 70 points by midday. The Nasdaq Composite Index also moved lower after the release of the text.

Then again, it's hard to imagine he would have been able to satisfy stock investors any other way. He didn't want to sound like the equity market's footboy, even if some believe that's how he's been acting for the past several months (and that's how the stock market believes he should act). Just the same, a crushingly pessimistic attitude would have roiled stocks, as the market hasn't really benefited from the rate cuts yet. So Greenspan needed to try to find that happy medium: a positive message about the future that doesn't come across as blind to ongoing issues.

"Clearly, he left the door open for more rate cuts, but he gave a large amount of qualifications," said Tony Crescenzi, chief bond market strategist at Miller Tabak. "The Fed is clearly in a more reactive stance now and a less proactive one, but he had to sound accommodating. He had to sound market-friendly or else risk undermining previous rate cuts."

The fixed-income markets have viewed Greenspan's evenhanded speech positively, strengthening the expectation that the Fed will indeed lower interest rates at the Aug. 21 meeting. Prior to the speech, the September fed funds futures contract, the market's proxy for monetary policy expectations, were discounting a 70% chance of an easing -- now, it's putting 86% odds on such an occurrence.

That's probably because Greenspan peppered his remarks with counterpoints to that charged statement, saying that more easing may be necessary because "we are not free of the risk that economic weakness will be greater than currently anticipated." He says the economic slowing could continue for some time (though the Fed's forecasts are relentlessly optimistic, figuring on 3% to 3.5% growth in 2002).

"This speech solidifies the view that you're going to get another 25 [basis points]," said Josh Feinman, chief economist at Deutsche Asset Management Americas.

Greenspan ended his speech by saying he believes the productivity enhancements that propelled economic growth in the latter part of the 1990s aren't likely to have run their course yet. Earlier in his comments, he took that a step further, saying demand should be assisted "by the inducement to resume increases in capital spending," sounding a bit like the market cheerleaders he once derided.

Otherwise, the usual obtuse platitudes apply. The proponent of Ayn Rand's philosophy summarized current economic growth and explained that the rapid-fire rate cuts, which brought the fed funds rate to its present 3.75% from 6.5% at the outset of 2001, were necessary because the Fed expects economic weakness to continue for some time.

The Fed chairman didn't go overboard discussing inflation, but, once again, didn't seem terribly concerned about it. Greenspan said only that slackening labor and product markets should reduce inflation in those areas. He acknowledged the uptick in the Consumer Price Index , but contrasted that with the personal consumption deflator, a gauge he said gets more of his attention.

Last, Greenspan said the Fed's central tendency for economic growth has been revised to a more realistic 1.25% to 2% for 2001, down from the 2% to 2.5% originally forecast back in February.