Greenspan's Neutrality Unleashes Huge Bond Rally

Fed Chairman Alan Greenspan's balanced comments on the economy ignited a massive bond rally today which slashed yields by 10 to 20 basis points. The shortest-maturity issues rallied hardest as investors interpreted Greenspan's words to mean the Fed won't necessarily hike interest rates again.

Greenspan didn't rule out additional hikes in the

fed funds rate. But nor did he signal that the Fed expects to have to raise rates again, as some investors feared he would.

Whether the Fed hikes rates again will depend on whether economic reports continue to show slower growth and low inflation, Greenspan implied.

While this is precisely what he was widely expected to say, fears that he might deliver an unfriendly message had prompted selling of fixed-income assets over the last week. When that proved unwarranted, the buying began, and it continued all day long.

The benchmark 10-year Treasury note was up 1 5/32 at 103 17/32 in late trading, dropping its yield 15.8 basis points to 6.007%, the lowest since July 13. Shorter-maturity yields, which are more directly influenced by the fed funds rate, fell even more. The two-year note, for example, shed 16 basis points to 6.329% as its price rose 7/32 to 100 2/32.

The 30-year bond gained 1 17/32 to 106 5/32, dropping its yield 10.4 basis points to 5.812%, the lowest since April 14.

At the

Chicago Board of Trade

, the September

Treasury futures contract rose 1 18/32 to 98 15/32.

In his semiannual Congressional

testimony on the economy and monetary policy, Greenspan dwelt at length on the various forces that may be bringing about the sustained slowdown in economic growth that the Fed is hoping for. These include stalled stock prices, high levels of consumer debt, high oil prices and the fact that consumers have been amassing durable goods and homes at a pace that cannot possibly be expected to continue.

"The more modest pace of increase in consumer spending in recent months suggests that aggregate demand may be moving closer into line with the rate of advance in the economy's potential," Greenspan

acknowledged.

But, he also pointed out that the evidence of a slowdown is still too new to be fully believed. "Certainly, we have seen slowdowns in spending in this near-decade-long expansion that have proven temporary, with aggregate demand growth subsequently rebounding to an unsustainable pace," he said. It is "much too soon," he added, "to conclude that these concerns are behind us."

Repeating a theme he has voiced many times before, Greenspan said the low rate of unemployment that has come about because of very strong growth puts the economy at risk of accelerating inflation. "Even if the growth rates of demand and potential supply move into better balance, there is still uncertainty about whether the current level of labor resource utilization can be maintained without generating increased cost and price pressures."

While he didn't rule out more interest rate hikes by the Fed, Greenspan's overall tone was far less hawkish than many market participants thought it might be. That made investors willing to put money on the slowdown. At the

Chicago Board of Trade

,

fed funds futures discounted 34% odds of a 25-basis-point rate hike next month, down from 54% yesterday.

"The impetus for the rally was the neutral testimony of Alan Greenspan when the market was expecting more hawkish, concerned type of testimony,"

Merrill Lynch

Treasury market strategist Jerry Lucas said. The monetary policy implication of the speech, he added, is: "The Fed's on hold, unless we get bad numbers."

There's plenty of opportunity for bad numbers. The weeks leading up to the next

Federal Open Market Committee meeting contain the

Employment Cost Index and

GDP report for the first quarter, and the

employment report,

retail sales report,

Producer Price Index and

Consumer Price Index for July. "I think it's a little premature,"

UBS Warburg

economist Jeffrey Palma said, to conclude that an August rate hike is unlikely.

Helping Treasury prices along today, the Treasury Department conducted its ninth buyback of long-maturity issues, purchasing $1.5 billion of 30-year bonds issued between 1991 and 1993 from dealers in order to take them out of circulation. The federal government has been using surplus funds to retire debt in this manner since March.

Economic Indicators

The

Philadelphia Fed Index

took an unexpected fall to 0.7 in July from 1.7 in June. Economists polled by

Reuters

had expected a rebound to 6.0, on average.

Housing starts

declined 2.6%, marginally less than expected, to an annual pace of 1.554 million in June from a revised 1.596 million in May. The June pace was the slowest since May 1998. However building-permit issuance, a leading indicator of housing starts, held steady at 1.511 million.

Initial jobless claims

retreated to 311,000 in the latest week from 320,000, but the four-week average edged up to a new one-year high of 307,750.

Currency and Commodities

The dollar fell against the yen and the euro. It lately was worth 107.68 yen, down from 108.31. The euro was worth $0.9329, up from $0.9242. For more on currencies, see

TSC's

Currencies column.

Crude oil for August delivery at the

New York Mercantile Exchange

fell to $30.93 a barrel from $31.42.

The

Bridge Commodity Research Bureau Index

fell to 223.37 from 223.52.

Gold for August delivery at the

Comex

rose to $280.40 an ounce from $279.60.