Greenspan Shocks Bonds Downward

The Fed chairman didn't disappoint in rocking the market this morning. The long bond, which was down all of 1/32 prior to Alan Greenspan's Humphrey-Hawkins testimony, dropped sharply after the release of the testimony on the Web, largely due to one sentence: "The Federal Reserve must continue to evaluate, among other issues, whether the full extent of the policy easings undertaken last fall to address the seizing-up of financial markets remains appropriate as those disturbances abate."

Ouch. The 30-year Treasury fell almost a full point, largely on the back of that statement, and lately was down 31/32 to 97 16/32, as the yield rose to 5.42%. The March long bond contract fell 26/32. Most were expecting a balanced assessment of the economy that might lean slightly to the hawkish side, and with that statement in the testimony, that's an accurate take.

"That's why we're rockin' and a-reelin' in here," said William Sullivan, chief money-market economist at Morgan Stanley Dean Witter. "It connotes the prospects of some upward movement in the funds rate as these 'disturbances abate.' But I think it's been given too much importance in early reaction to his remarks." 'Right now the market is predisposed to see the glass as half-empty today,' said A.G. Edwards' William Hornbarger. 'I really do think the market is getting more skittish; there was no real surprise in what he said.'

Contained within the Humphrey-Hawkins report are the Fed's expectations for gross domestic product growth, unemployment, and CPI. Expectations for 1999 GDP is now 2.5% to 3%, compared to the July 1998 report, when the 1999 forecast was for a 2% to 3% range. CPI forecasts were revised to 2%-2.5% from 1.5%-3%, and household unemployment forecasts were revised to 4%-4.5% from 4.25%-4.75%.

"That's an acknowledgment that the economy will continue to grow," said A.G. Edwards strategist William Hornbarger. "But right now the market is predisposed to see the glass as half-empty today. I really do think the market is getting more skittish; there was no real surprise in what he said."

Greenspan's testimony conforms to the usual even-handed assessment of the U.S. economy. Despite that statement, the chairman maintains that disturbances -- most specifically the pressures in the emerging markets -- have not disappeared. He cites Brazil as the most uncertain, saying it should walk a "very narrow, difficult path of restoring confidence and keeping inflation contained."

The chairman also seemed more concerned about the tightness in the labor markets and the ability of businesses to maintain the current pace of capital spending. He once again assailed current equity prices, which declined sharply on his comments. The Dow fell about 75 points before recovering, and the S&P 500 also dipped into negative territory before a rebound.

Greenspan, additionally, seemed more worried about the state of the labor markets than in the past, saying the "worker depletion constitutes a critical upside risk to the inflation outlook because it presumably cannot continue ... without putting increasing pressure on labor markets and on costs."

"But you have to remember that he indicates that inflationary risks are still uncertain," Sullivan said. "There is a controlling agent in this environment, namely the business that hires workers that sees a loss of pricing power. They're resisting pay increases and will continue to do so."

Fed Funds Rate Signals No Rate Hike

Yields on the March fed funds contract fell today to 4.77% from 4.78%, indicating confidence that the Fed will not raise rates at the next Fed meeting, scheduled for March 30. In his testimony, Greenspan said "recent experience does seem to suggest that the economy has become less inflation-prone than in the past, so that the chances of an inflationary breakout arguably are, at least for now, less than they would have been under similar conditions in earlier cycles."

"That suggests that there's no need to be preemptive," Sullivan said. "Going back four or five years ago, there was tremendous pressure to be preemptive."

By contrast, the June and July contracts have both widened out this morning, currently yielding 4.83% and 4.86%, indicating greater expectations of a Fed tightening during the summer.

The Fed chairman also said the Federal Open Market Committee will release statements at times after an FOMC meeting even if monetary policy has not been changed. (That is, if it moves to a tightening bias it'll tell the world now, instead of waiting until after the next meeting.)

Most early questions from members of the Senate Banking Committee were devoted to financial reform, which the Fed chairman was scheduled to testify on today as well.