What's wrong with this picture? The U.S. economy is enjoying strong growth that is far faster and far longer than anyone imagined. Meantime, general price pressures remain subdued. Productivity exploded in the second half of last year and, despite tight labor markets and a shrinking pool of available workers, unit labor costs have actually fallen for two consecutive quarters.

Apparently, some

Federal Reserve

officials want to ensure that this near-ideal situation does not last much longer and advocated a 50-basis-point hike at the February

Federal Open Market Committee meeting. We know that this view was still in the minority because the Fed lifted rates by only a quarter-point on March 21. However, many market observers think that the Federal Reserve should and will abandon the gradualism that has characterized monetary policy for the past eight months.

By the Fed's own admission, there are few signs that the rate hikes of recent quarters are having much impact. In the fourth quarter of 1999,

gross domestic product exploded at an almost 7% annualized clip, and many economists are forecasting that first-quarter growth will clock in at around 5%. Price pressures are rising, albeit very slowly and from very low levels. A rarified core of consumer prices, which excludes food, tobacco and energy, is currently rising at about a 2% annualized rate compared with a 1.6% rate six months ago. Gene Epstein of

Barron's

argues that the

CPI measure probably understates inflation in the housing sector. And oil prices remain stubbornly high even as oil-producing nations

prepare to boost output.

There is concern in some quarters that the Fed is slipping behind the inflation curve. A few observers have argued that the spread corporations have to pay over Treasuries is expanding -- an indication of greater risks. While I argued in a recent

column that the wealth effect created by the stock market is being exaggerated, many observers remain unconvinced. They believe that the recovery in the

Dow, the record highs in the

S&P 500 and the continued strong performance of the

Nasdaq signal continued wealth effect on consumer spending.

Color me skeptical. First, as I reported in this

space last week, the market has already discounted the strong likelihood that the Fed will hike rates another 50 basis points in the second quarter. Whether it comes in one blow in May or in two steps is not really that material.

Second, let's not exaggerate current inflation pressures. The Federal Reserve has made it clear that past inflation is not worrisome; the pipeline is not worrisome. Producer prices, excluding food and energy, are rising at about a 1% year-over-year pace, about half the rate seen a year ago. At 2.1%, core CPI prices are rising at about the same rate as a year ago.

Third, both the Old and the New economies are more energy-efficient, despite the popularity of gas-guzzling sport utility vehicles. Richard Berner, a senior economist at

Morgan Stanley Dean Witter

, pointed out recently that the U.S. economy is twice as energy-efficient as it was in the 1970s. For goods producers, the cost of materials -- of which oil is the most important component -- accounts on average for only about 8% to 12% of the sales price.

William McDonough, president of the New York Fed, seems to concur. In a recent speech, he pointed out that the oil-dependent sector of the economy is only about 3% of the total, compared with 8% in the 1970s. He acknowledged that there is no discernable evidence that higher oil prices are being passed through to nonoil-related sectors.

Fourth, we all know that the government's announcing its intentions to buy back $30 billion of outstanding debt this year has created a scarcity in some of the longer maturities with higher yields. At the same time, corporations and agencies appear to have stepped up their borrowings, in effect creating a relative surfeit. That is to say, the widening spreads are a reflection of relative supply considerations rather than systemic concerns.

Moreover, when the Federal Reserve is tightening monetary policy, it has made sense in the past to buy long-term bonds. In 1994, as the Fed hiked rates 250 basis points, bonds lost 10.5% of their value. However, in 1995, bonds rallied 34.8%. In 1999, the Federal Reserve raised rates 75 basis points and the bond market turned in its worst performance in history. The 30-year bond yield has dropped around 50 basis points in the first quarter. However, corporate borrowing costs have gone up, as reflected in the yield of S&P's BBB-rated corporate bonds, which

Alan Greenspan

is said to monitor as a more accurate picture of interest rates than the Treasury market.

There's good reason to suspect that after a strong first quarter, the economy will moderate in the second. Year-end bonuses, which an increasing number of American workers receive, have been spent or invested already. Tax refunds, which are running about 17% greater than last year, will wane as an economic factor. While many have been worrying (mistakenly, I think) about the inflationary implications of higher oil prices, another factor is often overlooked: The more the average American household spends on gasoline, the less money it can spend on other, arguably more discretionary goods. The higher oil prices may curb consumer spending.

Bottom line: Look for continued gradualism from the FOMC as it too wrestles with what Greenspan has called the discontinuous shifts in the structure of the economy.

Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

chandler.m@mellon.com.