Updated from 10:13 a.m. EST

In this morning's semiannual

testimony to the

Senate Banking Committee

,

Federal Reserve chairman

Alan Greenspan emphasized the ongoing weakness in the economy, indicating the Fed is likely to continue cutting rates.

He said, however, that the economic weakness didn't seem to have been as bad in January as it was in December. The markets have put together a bit of a rally in response, but it's no barnburner.

Greenspan, in the testimony formerly known as

Humphrey-Hawkins but now simply referred to as the "monetary policy report to Congress," made it clear that the Fed views recession as a very real possibility, one that can occur too quickly for monetary policy to anticipate. As is his nature, he balances out what he sees as positive developments with negative aspects of the economy, but he makes explicit that the Fed is focused on combating more economic weakness.

"The exceptional weakness so evident in a number of economic indicators toward the end of last year (perhaps in part the consequence of adverse weather) apparently did not continue in January," Greenspan said. "But with signs of softness still patently in evidence at the time of its January meeting, the FOMC retained its sense that the risks are weighted toward conditions that may generate economic weakness in the foreseeable future."

The likelihood of recession (and the unpredictable nature of its arrival) is at the forefront of the chairman's mind. Expanding on his points from a question-and-answer period during his Jan. 25

speech to the

Senate Budget Committee

, Greenspan said economic models haven't been successful in "capturing a process driven in large part by non-rational behavior."

"Looking back at recent cyclical episodes, we see that the change in attitudes has often been sudden. In earlier testimony, I likened this process to water backing up against a dam that is finally breached. The torrent carries with it most remnants of certainty and euphoria that built up in earlier periods," he said. "This unpredictable rending of confidence is one reason that recessions are so difficult to forecast. They may not be just changes in degree from a period of economic expansion, but a different process engendered by fear."

Among the concerns highlighted by the Fed chairman were the marked decline in consumer confidence, the tightening of lending standards, and the drop in production due to a massive inventory overhang. Changes in consumer confidence, according to Greenspan, are unpredictable when economic fundamentals shift suddenly; a downturn in confidence can sap demand quickly and suddenly, which feeds consumers' thinking, which saps demand further, and so on and so forth.

"It is difficult for economic policy to deal with the abruptness of a break in confidence," Greenspan said. "There may not be a seamless transition from high to moderate to low confidence on the part of businesses, investors, and consumers."

Taxes, Taxes and More Taxes

So far, the members of the committee are using the question-and-answer period to pepper him with questions about tax cuts. It's a game that's been played before; Republicans voice support for tax cuts and ask for Greenspan's support; Democrats urge fiscal responsibility and try to win over Greenspan to their argument, the Senators argue (which is what they're doing now) and Greenspan, ultimately, doesn't lean one way or the other.

Greenspan, as in the past, said today he believed tax cuts were a prudent measure. However, he waved off the various Senators asking him to support a particular plan. And so it goes.

Meanwhile, Greenspan's even-tempered approach to his testimony, where he acknowledged improvement in financial conditions and economic conditions, has the market thinking the Fed's monetary policy committee will be less aggressive at the upcoming meeting. The March

fed funds futures contract, the market's best indication of what the market thinks the Fed will do, is currently factoring in a 90% chance the Fed cuts by 50 basis points to 5%, compared with a 100% chance as of yesterday.

Greenspan said the Fed's consensus forecast for economic growth for 2001 had been lowered to a range of 2.5% to 2% from a previous estimate of about 3.75% to 3.25%, citing recent declines in consumer demand and business investment. But that still anticipates an economic recovery in the second half of the year.

Buried in Greenspan's speech was perhaps the best codification of how he views the stock market as an indicator at this point in time.

Greenspan has often received criticism for seemingly reacting to stock prices rather than economic issues (and he's been blasted for not acting when the market demanded it). He testified that the heightened awareness of consumers about the market and the growth of the investing base in the country has made the stock market a more important indicator of potential spending patterns.

"Stock market wealth has risen substantially relative to income in recent years -- itself a reflection of the extraordinary surge of innovation," he said in his testimony. "As a consequence, changes in stock market wealth have become a more important determinant of shifts in consumer spending relative to changes in current household income than was the case just five to seven years ago."