Greenspan in a Bottle: The Market Isn't Getting the Message

The Fed keeps talking slowdown in hopes that one will spring to life, sparing the U.S. from recession.
Author:
Publish date:

Who Is John Galt?

JACKSON HOLE, Wyo. -- And today we wonder.

The table above maps a recent

history of the two-year

Treasury

note, the 10-year Treasury note, the 30-year Treasury bond and the real

federal funds

rate. Note that the real funds rate equals the nominal funds rate less the

12-month change in the core (excluding food and energy)

Consumer Price Index

; note also that the

FOMC

tightened on June 30.

Now. It will occur to even the casual observer that those three market rates and the real policy rate are all now kinder than they were (on average) during the 1996-1998 period. And that was a period, mind you, that delivered steady and stellar economic growth. Indeed,

gross domestic product

grew 3.4% during 1996 and 3.9% during both 1997 and 1998.

So one could be forgiven for wondering why it is that, what with financial conditions still entirely accommodative and especially now that growth elsewhere seems to have troughed,

Alan Greenspan

will plop down two days hence and tell us all that the economy is set to slow.

And he will.

The

Feds

have been doing precisely that for more than three years.

They

predicted 1996 growth would come in (on a fourth-quarter-to-fourth quarter basis) as little as 2.5% and no bigger than 3%.

It came in at 3.9%.

They

predicted 1997 growth would come in as little as 2% and no bigger than 2.5%.

It came in at 3.8%.

They

predicted 1998 growth would come in as little as 1.75% and no bigger than 3%.

It came in at 4.3%.

And even if G. Love does alert us on Thursday to an upward revision to the original 1999 forecast -- the Fed

predicted back in February that 1999 growth would come in as little as 2% and no bigger than 3.5% -- he will tell us that the economy will slow next year.

Why? As the forecast nuggets taken from the

minutes of FOMC meetings as far back as January 1996 below show, just because.

The staff forecast prepared for this meeting suggested that economic activity would expand at a relatively slow pace over the near term.

The staff forecast prepared for this meeting pointed to considerable slowing in the expansion of economic activity in the year ahead to a pace somewhat below the estimated growth of the economy's potential.

The staff forecast prepared for this meeting continued to point to considerable slowing in the expansion of economic activity to a pace appreciably below the estimated growth of the economy's potential, but the expansion was expected to pick up later to a rate more in line with that potential.

The staff forecast prepared for this meeting indicated that economic activity would expand more slowly over the projection period than it had in recent years.

The staff forecast prepared for this meeting suggested that the economy would continue to expand for a time at a pace considerably above its potential, but growth was expected to moderate to a more sustainable rate later.

The staff forecast prepared for this meeting suggested that the expansion of the economy would be damped in the second half of the year by a slowing of inventory accumulation from the unsustainably brisk pace in the first half of the year.

The staff forecast prepared for this meeting suggested that the economy would expand at a pace significantly above that anticipated earlier for the second half of the year and the early part of 1998, but economic growth was likely to moderate appreciably to a more sustainable rate later.

The staff forecast prepared for this meeting incorporated a considerably weaker assessment of underlying aggregate demand, owing to downward revisions to growth abroad and to the less accommodative conditions that were evolving in U.S. financial markets.

The staff forecast prepared for this meeting indicated that the expansion of economic activity would slow considerably during the next few quarters and remain moderate in 1999.

The staff forecast prepared for this meeting indicated that the expansion of economic activity would slow appreciably during the next few quarters and remain moderate in 1999.

The staff forecast prepared for this meeting indicated that economic activity would expand through 1999 at a pace somewhat below the estimated growth of the economy's potential.

Got the idea? And the Feds ain't the only ones who've been stuck on the slowdown idea. Plenty of private-sector forecasters have doggedly been calling for the same thing, and they've been barking even louder since the Fed tightened three weeks ago.

Again. Why?

Look back at the table above. Is it that long rates rose during the first half of the year? That they now stand as much as 44 basis points over their 1998 levels?

Fair enough. Say that a half-point increase in the 10-year note yield does subtract (as the economic forecasters at

Salomon Smith Barney

estimate) about 0.4 percentage point from growth over the succeeding four quarters.

Is a slowdown in the pace of economic growth to 3.6% from 4% meaningful? Is it material enough to prevent labor markets from getting even tighter?

No and no.

Well, then what about the real funds rate? Is it not more restrictive now than it was a month ago? Surely the markets got the Fed's message.

Are you kidding? Sales of interest-sensitive goods like vehicles and houses refuse to quit setting records under such a "restrictive" rate regime. And as for the markets getting the message?

Recall this G. Love

nugget from a month ago.

Overall economic growth during the past three years has averaged 4% annually, of which roughly 2 percentage points reflected increased productivity and about 1 point the growth in our working age population. The remainder was drawn from the ever decreasing pool of available job seekers without work. That last development represents an unsustainable trend that has been produced by an inclination of households and firms to increase their spending on goods and services beyond the gains in their income from production. That propensity to spend, in turn, has been spurred by the rise in equity and home prices, which our analysis suggests can account for at least 1 percentage point of GDP growth over the past three years.

Here's a guy who clearly wants the economy to slow -- and whose only real hope toward that end rests on adjusting a policy rate to make an unsustainable trend more sustainable before it blows up in our faces.

And what was the result of the June 30 policy action?

Market rates are even lower; yields have fallen across the curve. Mortgage rates dipped; they now sit just 13 basis points north of their 1996-1998 average (7.58% against 7.45%). Shares rose; the

S&P 500

measure, which was up 11.7% year-to-date then, is up 14.5% now.

Uh-huh. The markets got the message all right.

'Swim!' said the mama fish. 'Swim if you can!'

Things have gone swimmingly during the past few years despite the fact that our central bankers have failed to forecast either growth or the price measures with any degree of accuracy at all.

Some folks would chalk the result up to skill, in which case we have nothing to fear. The Fed is on the case, and it can do no wrong.

Other people would chalk it up to good luck.

And the problem with good luck, of course, is that it always runs out.

Side Dish

Also wanted to include

Atlanta-Milwaukee

. Damn our five-slot polling technology.

Best baseball rivalry?

Chicago-Chicago.

Boston-New York.

Chicago-St. Louis.

New York-New York.

Los Angeles-San Francisco.