In three short paragraphs, Greenspan drove home the point that the economy was riding out its "soft patch," seeming to emphasize that a widely expected quarter-point hike in the Fed funds target rate on Sept. 21 is all but certain. Investors, however, were quick to look past this restatement of the obvious. Instead, they jumped on Greenspan's low inflation expectations as an omen that the monetary policy trajectory will remain "measured" going forward.
And even Fed members at the more dovish end of the spectrum -- those who believe fostering economic growth should get equal billing to focusing on price stability -- have been more upbeat on the economy. Indeed the doves have indicated that they expect that the Fed still has more work to do to achieve policy neutrality.
BOND MARKET COMFORT. For example, Dallas Fed President Robert McTeer said on Sept. 7 he was hopeful that the economy's "soft patch was behind us" and forecast a gross domestic product rebound in the second half. He also reiterated that the real Fed funds rate -- as adjusted for inflation -- is still "negative-to-zero" despite the recent rate hikes, and he doesn't see inflation becoming a major problem "for the next year or so."
Those relaxed sentiments on inflation were also reflected in Greenspan's testimony, which gave the forward-looking bond market some comfort. Despite high oil prices and rising unit-labor costs, Greenspan stated, "as best we can judge, the growth in profit margins of nonenergy, nonfinancial corporations, which, at least from an accounting perspective, had contributed significantly to price pressures earlier, has recently slowed." He also noted that increases in nonoil import prices have lessened, which, coupled with the slowing of profit-margin growth, has helped reduce the rate of core consumer price inflation in recent months.
On the economy, Greenspan was to the point: "The most recent data suggest that, on the whole, the expansion has regained some traction." He cited improved consumer spending and housing starts data for July, after weak performances in June, although early readings on retail sales in August have been mixed. The Fed chief also noted a "solid upward trend" in business investment.
ONE-MONTH CHANGE. As for key sectors, Greenspan pointed out that manufacturing output has continued to move up in recent months, though part of that could likely be chalked up to a boost in inventory investment. And he noted the recovery in nonfarm payroll growth in August, though job gains were down from last spring's peak.
Though the chairman equivocated on the August retail sales readings, in keeping with recent warnings from Wal-Mart (WMT
) and chipmaker Intel (INTC
) of slow back-to-school sales so far, the broad sweep of his economic view was clearly more optimistic than just one month ago. Consider what the policymaking Federal Open Market Committee had to say in its Aug. 10: "In recent months, output growth has moderated, and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices."
The Fed's Beige Book survey of economic conditions was released shortly after Greenspan concluded his House testimony and didn't generally contradict him. The report from the Fed's 11 regional banks said the economy "continued to expand in late July and August."
SHIFTING FOCUS. But some seeds of doubt were present. Perhaps reflecting the proximity of the technology sector, the report compiled by the San Francisco Federal Reserve Bank found that growth had slowed in several regions, and the pace of household and retail spending had eased -- with the housing sector -- through August. It also noted that payrolls continued to expand, though growth was uneven across various sectors. In all, the Beige Book provided a slightly more downbeat outlook for the September FOMC meeting than the markets had expected.
After being driven higher by Sept. 3's August employment report and upward revisions to June and July payrolls, Treasury yields moved lower during the testimony as dealers chose to focus on low inflation expectations rather than the economic upgrade. The yield on the benchmark 10-year note, after some early pre-testimony jitters in low trading volume, plunged back below 4.2%. The dollar followed U.S. yields lower, and stocks, which never really regained their footing, finished lower.
Despite this initial reaction by the markets to Greenspan's tempered testimony, at Action Economics we expect the Fed to carry out successive quarter-point hikes as far as the eye can see -- or, at least at each of its policy meetings through the first half of 2005. Wallace is global market strategist for Action Economics