If businesses are still exhibiting cautious behavior, as Federal Reserve Chairman Alan Greenspan suggested last week, it's not evident from a slew of first-quarter conference calls or recent economic data. Prudent investors might consider the implications for April's employment report. In speaking before the Joint Economic Committee Wednesday, Greenspan seemed to suggest there was no urgency to raise interest rates because "some of the strains that accompanied the difficult business environment of the past several years apparently still linger." Specifically, he said, firms are reluctant to anticipate and prepare for future orders and are similarly cautious in their hiring decisions. But CEOs from some of the nation's largest companies have been unusually ebullient about the state of the economy recently and several firms have hinted they will increase hiring this year. In part, the gap between what companies and the Fed are saying reflects the fine line Greenspan must walk during an election year. Despite its mandate for autonomy, the Fed has traditionally shied away from raising rates in the three months before a presidential race is decided. If that reluctance holds, it leaves the FOMC with a rapidly closing window in which to enact a tightening, making the always-thorny task of interpreting Greenspan's intentions that much harder for stock investors. The difficulty of knowing what Greenspan is planning showed up in last week's stock market price action, and could mute trading at least until the April employment report arrives. Stocks plunged on Tuesday when the Fed chairman told Congress that deflation had receded as a primary Fed concern, regained the ground a day after he said broad-based inflation remains a concern, then eased again Friday. For the week, the major indices ended moderately higher, with an outperforming Nasdaq washing out its losses from a week earlier. Notably, the last time stocks posted anything approaching a decisive move was in the runup to and aftermath of the March employment report, when the government said payrolls rose by more than 300,000. Since bottoming around 10,000 a week before the number hit, the Dow has tacked on close to 500 points as investors celebrated the arrival of a long-awaited economic rebound. But what was manna a month ago could easily be poison today: a blowout number might confirm investors' worst fears about the imminence of a rate hike. A recent survey by the National Association for Business Economics found that business hiring will expand over the next six months, and 53% of respondents said they expect capital spending at their firms to increase this year. "It appears the world economy will have one of the strongest, broadest recoveries in years," said Jim Owens, chairman and chief executive officer at Caterpillar ( CAT). Owens said his firm will need more people through the remainder of the year to keep pace with volume growth. Microsoft ( MSFT) Chief Financial Officer John Connors said his firm is "still adding people," noting that "we are in the midst of a corporate recovery." Meanwhile, General Electric ( GE) CEO Jeff Immelt said economic growth "is continuing at a strong pace," while companies from Yahoo! ( YHOO) to J.C. Penney ( JCP) to Motorola ( MOT) have been increasing their guidance. Recent economic data also suggest that corporate America is increasingly optimistic about the economic outlook. The government said Friday that durable goods orders surged 3.4% in March after an upwardly revised 3.8% gain in February.
"These orders reflect the restocking of inventories, and that stems from increased confidence," said John Lonski, chief economist at Moody's. The Federal Reserve's beige book report also noted that labor markets "tightened somewhat with modest wage increases," and first-time jobless claims fell by about 9,000 in the week ended April 17. In addition, inflation has started to creep higher recently, with both consumer and producer prices rising more than expected in March. However, while Fed Governor Ben Bernanke acknowledged to the Bond Market Association Friday that the economic recovery has shown signs of becoming self-sustaining, he noted, like Greenspan, that "it is not yet clear that employers have overcome their reluctance to hire at a normal pace." A speech by another Fed governor, Susan Bies, echoed those remarks, saying that while economic activity has been strong, "the labor market has improved at an unusually slow pace by historical standards." Lonski said Fed officials are emphasizing areas of weakness in the economy -- and downplaying recent signs of inflation -- because they are trying to prevent a panic in the financial markets. "The Fed is telling the financial markets 'Don't behave as though the federal funds rate is on the verge of being lifted to 4%.' " The Fed funds rate currently sits at a 45-year low of 1%. Still, Lonski does believe the Fed will raise rates by as much as 125 basis points this year, saying he believes nominal GDP growth could be in a range of 6% to 6.5% in the second half of the year. Other economists also are calling for aggressive tightening this year despite seemingly dovish remarks from Fed officials. J.P. Morgan is now forecasting a 2% fed funds rate by year-end and a 4% rate by the end of 2005.
More significantly, perhaps, is that financial markets have raised the odds for an interest rate hike by June and are now forecasting 50 basis points of tightening by the Sept. 21 meeting. Fed funds futures contracts are pricing in a 90% chance that the funds rate will hit 1.5% by September. The odds for a rate hike in June have increased to 46%. Judging by the performance in the stock market of late -- all three major stock averages ended in positive turf last week -- it's not clear that participants are prepared for a series of rate increases. Whether Fed officials have lulled investors into a false sense of security, or whether investors actually care more about a stronger economy than a rate hike, remains to be seen.