Greenspan's Fine Line Before Congress

Stock investors love a low-rate environment, but the dollar and oil could complicate policy views.
By Rebecca Byrne ,

Federal Reserve

Chief Alan Greenspan has a delicate balance to strike this week.

When he delivers his semiannual monetary policy to Congress Wednesday and Thursday, stock investors will be looking for more signs that interest rates are on hold for a long time. But if Greenspan gives in to these demands, he risks sending the dollar even lower and oil prices up from already lofty levels.

Over the weekend, the Group of Seven industrialized nations gave the dollar free rein to fall by repeating their calls for greater exchange rate flexibility. Although the G7 added a qualifier that "excess volatility and disorderly movements in exchange rates are undesirable," the dollar has fallen to new lows against the euro this week.

Meanwhile, the Organization of Petroleum Exporting Countries said Tuesday that it planned to cut oil production by 1 million barrels a day starting April 1. OPEC is hoping to prop up prices during a seasonal slowdown in demand. But officials are also keeping prices high as a result of weakness in the dollar.

Oil producing countries sell oil in U.S. dollars and buy goods in a basket of other currencies, so a slide in the greenback can hurt their purchasing power. Nymex crude rose 62 cents to $33.45 a barrel Tuesday, while the dollar was sitting close to a three-week low against the yen and euro.

So what's the Fed chief going to say? In all likelihood, Greenspan will reiterate his mantra that the central bank will remain patient in raising rates. After all, the slide in the dollar isn't considered to be too painful, at least not yet. Although some analysts worry that a continued decline will prompt foreigners to take their money out of U.S. assets, the fear has proven unfounded so far.

The latest available data show that foreigners' appetite for stocks and bonds remains voracious. In November, purchases of U.S. stocks and bonds jumped 217% to $87.6 billion, after a 560% jump in October.

A weaker dollar also has positive ramifications for companies that do a lot of business overseas. It is considered a "natural cure" for the major imbalances plaguing the U.S. economy, especially the huge trade deficit.

Economists are also nonchalant about higher oil prices right now, in part because they expect these costs to fall going forward. And even if prices do remain at elevated levels this year, the impact to the U.S. economy is likely to be muted, given that growth is expected to be so strong.

Goldman Sachs said it doesn't expect Greenspan's testimony to "break new ground," but the ranges for expected growth and employment could change from last year's provisional settings "in ways that could affect market perceptions of how 'patient' the committee will be in maintaining current monetary accommodation."

Goldman said the expected range for unemployment could move down by quarter point from a current level of 5.5% to 6%. The range for expected economic growth, meanwhile, could move up by a quarter-point. "Changes in 'central tendency' ranges for expected growth and employment may feed market expectations that tightening will begin in 2004," Goldman said in a report.

A hawkish statement would naturally disappoint equity investors while alleviating downward pressure on the dollar. Dovish testimony, on the other hand, would likely send the dollar to fresh lows against the euro and potentially force the European Central Bank to intervene and/or lower interest rates.

"Such a scenario would also renew downward pressures on USD-JPY and USD-Asia," said Merrill Lynch foreign exchange strategist Yianos Kontopoulos in a research note. "After some weeks of confusion, we are close to clearing the mist in

foreign exchange markets."

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