Along with many other Fed watchers we have spoken with, we expect Greenspan to merely elaborate on what has been noted in most of the Fed policy announcements this year: that economic activity has been picking up, but the strength of final demand remains uncertain. The Fed chief is likely to be relatively bullish on the economy's fundamentals longer term, while acknowledging some of the near-term problems that weigh on Wall Street.
BALANCING ACT. How much he'll be able to help market sentiment -- and allay investor fears over the recent scandals -- is unclear. With the dramatic plunge in investor confidence and the corresponding concerns that it will nullify the recovery, the markets naturally look to Greenspan for leadership out of the morass. The key will be how he balances souring expectations and lost investor trust on Wall Street against signs of an improving economy.
Some observers suspect he might warn of increasing headwinds hitting the economy from the debacle on Wall Street -- and consequently hint that a more accommodative Fed policy posture is possible. But we don't think so. Nor do the many market professionals that we surveyed. They think that would be an inappropriate response.
We think Greenspan has learned his lesson from his "irrational exuberance" remark in 1996 and thus isn't likely to characterize today's equity weakness with the same adjective. But while not exactly calling investor pessimism and lost confidence "irrational," he can point out the positive underpinnings of the economy -- ones that normally should be supporting stocks. With the exception of a couple of soft patches, recent data reports have reflected a healthy, if not solid recovery.
CRUCIAL TAKEAWAY. Indeed, the Federal Open Market Committee, the Fed's rate-setting arm, has consistently acknowledged in its policy statements that economic activity is picking up. However, it has also included the caveat that the degree of strengthening remains cloudy. Picking up on this theme, Greenspan can factor into his testimony the potential barriers to growth from the erosion in equity wealth and its potential negative impact on final demand.
The crucial takeaway for the markets will be just how optimistic the Fed chief is on real growth -- and how much he pins the losses on Wall Street to a crisis of confidence. Any suggestion that growth will be seriously harmed by the recent events on Wall Street should increase expectations that the Fed, which earlier this year had been expected to tighten rates as early as September, will instead remain on hold for an extended time. But we doubt Greenspan will show sufficient concern to suggest that any rate cuts may be in the offing. Rupert is a senior economist for Standard & Poor's/MMS InternationalWith additional analysis from MMS staff economists