Greenspan Says 'Expansion,' and Rate-Hike Talk Jumps

Alan Greenspan gave Senate testimony Thursday that deviated only slightly from what he told the House last week. But for some observers those changes made all the difference.

Just as he did a week ago, the chairman emphasized the balance between forces stoking the economy and those holding it back. This time around, however, Greenspan suggested the healing process is much further along. And that is making bond market investors think the Fed is that much more likely to raise interest rates soon.

Most important, Greenspan led with a subtle, but to many minds monumental, acknowledgment that growth has resumed. "The recent evidence increasingly suggests that an economic expansion is already well under way," the Fed chief said in his opening remarks.

By contrast, last week he had opened by warning that "an array of influences unique to this business cycle ... seems likely to moderate the speed of anticipated recovery." Notably, on Thursday morning Greenspan got around to that part only after using the widely heralded "E" word.

Expansionists

For Fed watchers -- once upon a time the kids who could tell you Cliff Mapes' lifetime stats -- that change in the testimony was manna.

"Everybody picked up on that," says Miller Tabak bond market strategist Tony Crescenzi. "He didn't call it a recovery, he called it an expansion."

A mere recovery, according to Crescenzi, can be a flimsy thing. An expansion, however, suggests that the economy has entered a phase in which growth can reinforce and sustain itself. "The more the recovery is self-reinforcing, the more likely it seems that the Fed will raise interest rates," says Crescenzi.

Crescenzi also notes that Greenspan knew investors would be watching carefully for any changes in his text, and would modify their view on Fed policy as a result. His alterations seem inconsequential, but he knew they'd carry weight. As they have. The fed funds futures market, which before Greenspan began speaking gave a 37% chance of a quarter-point rate hike at the May Federal Open Market Committee meeting, now puts the odds at 50%. Stocks, which generally trade better the lower rates are, remained mixed throughout the Fed chief's remarks.

The Gospel Truth

Of course, given the economic data that have come out since Greenspan penned his House testimony, the changes shouldn't surprise. Since then, we've seen a strong January durable goods report, an impressively strong revision to fourth-quarter gross domestic product and a stunning upside surprise on the February purchasing managers' indices. The Fed has cut rates 11 straight times since the start of 2001.

Though it's rare for Greenspan to tweak testimony, by now "it would seem to be just stubborn to dismiss the notion that a recovery is under way," says Northern Trust chief U.S. economist Paul Kasriel. "Because it clearly is."

Kasriel also says the changes should disabuse investors of the notion that everything the Fed says is gospel. That Greenspan could modify his views after only a week suggests that he's watching each tick of the data -- just like everybody else.