It looks like rates are on hold for now, which is good for stocks and decent for bonds, too.
In testimony that borrowed freely from his recent speeches, Federal Reserve Chairman Alan Greenspan told Congress Wednesday that he believes the economy is on the brink of recovery, if it isn't rebounding already. But Greenspan also said significant headwinds will soften the early bounce.
The implication is that the Federal Open Market Committee is likely to leave the fed funds rate alone for most of 2002. The interest rate target is already at a 40-year low of 1.75% after 11 rate cuts over the past year or so. Wednesday morning, the major stock indices rose about 1% on the back of Greenspan's mildly bullish comments and
other solid economic data.
In something approaching English, Greenspan laid out his thesis early in the speech. "Despite the disruptions engendered by the terrorist attacks of Sept. 11, the typical dynamics of the business cycle have re-emerged and are prompting a firming in economic activity," he said. "An array of influences unique to this business cycle, however, seems likely to moderate the speed of the anticipated recovery."
Thanks to the sharp reduction in inventories, said Greenspan, the economy appears to be on the cusp of a rebound. Inventory reduction detracts from the economy, because companies slow down production while they sell off excess goods. Once inventories have been cut bare (and in most recessions companies end up cutting by too much), production picks up again. "That rise in production will, other things being equal, increase household income and spending," said Greenspan.
But the forces that typically carry the recovery past that first, inventory-related boost may be muted, Greenspan worried.
For one thing, consumer spending remained strong through the downturn, whereas in the typical recession it gets heavily dented. That provided the economy with a "stabilizing force," said Greenspan, but it also means that it won't contribute the kind of lift that it usually does in recovery.
The other factor that will damp the economy's recovery will be a slow rebound in capital spending. The unwinding of Corporate America's ill-gotten spending spree on equipment, particularly in the tech and communications arenas, continues to exert a drag on the economy. A slower-than-usual rebound in capital spending, Greenspan suggested, will be another force muting recovery.
What struck Fed watchers most about the testimony was how carefully balanced it was, engendering in the market a faith in economic recovery and at the same time a belief that the Fed will be slow to raise rates. The stock market responded well to Greenspan's message of recovery -- the
Dow Jones Industrial Average
was lately up 115 points -- but the bond market, which tends to run counter to stocks these days, held its ground on the notion that monetary policy is on hold.
"He highlighted a lot of risks," says Miller Tabak bond market strategist Tony Crescenzi, "but he didn't do it in a way that would provoke pessimism in the economic environment. He struck the right balance by hitting on opposing points."
Crescenzi also noted that the extent to which Greenspan borrowed from past speeches was probably so that he could be sure of the market reaction -- a notion that other Fed-watchers seconded. Moreover, Greenspan didn't introduce any new material in this testimony, instead merely expanding on past themes while throwing in recent data.
"It was as plain vanilla as he could have got," says Salomon Smith Barney economist Steve Wieting. The message: "This is a Fed on hold."