Hawkish comments by Fed Chairman Alan Greenspan took the steam out of a bond-market rally triggered by a friendlier-than-expected report on inflation at the wholesale level.
Without suggesting that the
Federal Open Market Committee
will hike the
fed funds rate
more than 25 basis points at its next meeting on March 21, Greenspan indicated that rates will continue to rise until stock prices stop rising at a faster pace than incomes. Incomes have grown about 6% a year for the last three years. Stock prices rising faster than incomes is helping cause growth in demand for goods and services in excess of supply, Greenspan said. And that's a recipe for higher inflation.
Noting that the interest-rate-sensitive sectors of the economy have not slowed substantially even though rates have risen, the Fed chairman said: "
The FOMC will have to stay alert for signs that real interest rates have not yet risen enough to bring the growth of demand in line with that of potential supply, even should the acceleration of productivity continue."
And, in a departure from previous speeches, in which he has characterized rising productivity as a force of unmitigated good, Greenspan offered this thought:
The problem is that the pickup in productivity tends to create even greater increases in aggregate demand than in potential aggregate supply. This occurs principally because a rise in structural productivity growth has its counterpart in higher expectations for long-term corporate earnings. This, in turn, not only spurs business investment but also increases stock prices and the market value of assets held by households, creating additional purchasing power for which no additional goods or services have yet been produced.
"This is not your traditional economics right now,"
senior economist Ethan Harris commented. Increasing productivity "certainly is a good thing, but it's become more of a mixed blessing now that the stock market has reached a point where the cumulative gains are so big." Today's $17 trillion stock market creates three times as much wealth when it rises 10% than the $5 trillion stock market of 1993, he pointed out.
The benchmark 10-year Treasury note finished down 6/32 at 99 16/32, lifting its yield 2.6 basis points to 6.569%. The 30-year Treasury bond -- displaced as the benchmark in recent weeks because the government's plan to reduce the supply of long-dated issues has driven up its price disproportionately -- rose 18/32 to 100 11/32, trimming its yield 4.1 basis points to 6.224%. Trading desk sources said the long bond got a big boost after Greenspan's speech by a large buyer of bonds and bond futures who was simultaneously selling eurodollar futures. Eurodollars are a more liquid proxy for the fed funds rate.
Chicago Board of Trade
, the March
Treasury futures contract ended up 15/32 at 94 5/32.
"Things are so thin in bondland now, so illiquid, that one heavy-handed buyer comes in and can really drive it," said Mark Mahoney, Treasury market strategist at
Warburg Dillon Read
The bond market's relatively muted reaction to Greenspan -- historically, Humphrey-Hawkins testimonies have triggered much larger moves -- shows that his hawkishness on interest rates was well-anticipated. The course of action that Greenspan hinted at is more or less the one that the market has priced in. That course of action, Fed-watchers say, is more rate hikes, but at a gradual pace. Meaning that rate hikes are unlikely to come in increments greater than 25 basis points. If a larger rate hike were in the offing, Greenspan would have taken this opportunity to signal it, they say. "To the markets, saying nothing
about a 50-basis-point hike is like saying he's not thinking about it,"
senior economist Henry Willmore said.
fed funds futures
listed at the CBOT upgraded the risk of a 50-basis-point rate hike only slightly, to 62% from 59%.
Earlier this morning, a much friendlier-than-expected report on wholesale inflation gave bond prices a small boost.
Producer Price Index
was unchanged, well below the average forecast of economists polled by
for a 0.2% gain. Excluding food and energy prices, the PPI declined 0.2%; the core rate had been expected to rise 0.1%.
The lack of change in the PPI caused its annual pace to slow to 2.5% from 3% in December. That's the slowest pace since August. The core PPI slowed from 0.9% to 0.8%, the slowest pace since June 1998.
While these trends are important, investors will look to tomorrow's
Consumer Price Index
for January to confirm that inflation remains broadly in check.
Philadelphia Fed Index
, drew a very different conclusion. While the index itself rose only a little, to 13.3 from 9.1, a sub-index that measures prices paid by Philadelphia-area manufacturers rose sharply, from 21.9 in January to 40 in February, the highest reading since March 1995.
The Treasury market also drew early support from a nice gain by the dollar against the yen. The dollar moved higher against the yen after
Moody's Investors Service
, the bond rating agency, said it was putting Japan under review for a possible
downgrade. Japan lost its top-notch triple-A Moody's rating in November 1998 and is now rated double-A by the agency.
Also today, the weekly count of
initial jobless claims
indicated continued tightness in the labor market. The count dropped from 303,000 to 283,000. Four weeks ago, it dropped to 264,000, the lowest level since the early 70s.
Currency and Commodities
The dollar rose against the yen and the euro. It was lately worth 110.62 yen, the highest since September, up from 109.40 yesterday. The euro was lately worth $0.9875, up from $0.9866 yesterday.
Crude oil for March delivery at the
New York Mercantile Exchange
fell to $29.46 a barrel, down from $30.05 yesterday.
Bridge Commodity Research Bureau Index
fell to 212.71 from 212.97 yesterday.
Gold for April delivery at the
fell to $303.80 an ounce from $305.30 yesterday.