All eyes are on Federal Reserve Chairman Alan Greenspan as he gears up for his next big move
By Noam Neusner
Stock market investors feel pretty good again, jobless claims are falling, news headlines (including U.S. News) trumpet a rebound, and even manufacturers--typically the Gloomy Guses of the economy--show some kick with rising orders. So why did Alan Greenspan, in a recent speech, hint that the economy still needs his magic touch? We should learn more in coming weeks, when the Federal Reserve is expected to cut interest rates again--the 12th time in 13 months.
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While the rate cuts, combined with a decline in energy prices and tax rebates, have shored up consumer spending, corporate profits remain soft. That has put a crimp in business spending on factories and equipment and raised the likelihood of more layoffs. Plus, while the Fed's earlier cuts helped make short-term borrowing cheap, they haven't done much for those whose long-term loans depend on the 10-year U.S. Treasury note (chart). To Greenspan, the stubbornness of long-term interest rates isn't a small worry. Quite the opposite. To his thinking, that rigidity is probably holding back the recovery.
While some Wall Street economists proclaim the recession over, Greenspan has to weigh that optimism against the fact that it isn't yet. "Why not run the risk of cutting too much?" asks Tom Gallagher, senior managing director at ISI Group, an economic policy group. "Better to err on the side of caution."
Still, Greenspan must step gingerly. The bond market is nervously watching. An economy in recession doesn't worry bond investors. But as the economy rebounds, those investors fret that inflation will erode the value of their loans unless they get higher interest rates. Cut rates too little, and the economy will scream. Cut too much, and bond investors will.
That's why some Fed watchers say Greenspan's next move will be nuanced. He'll cut rates one more time but also declare the economy to be "balanced," Fed-speak for alerting investors that rate cuts are history. "What he wants to do is cut rates and still tell the bond market that there will not be inflation," says Chris Low, chief economist at First Tennessee Capital Markets. The result, Low predicts, will be a bond-market rally that will bring down long-term interest rates, boosting borrowing and spurring growth.
Cash cow. Sound too good to be true? Could be. Greenspan's efforts to pare long-term rates are running smack-dab into the new age of budget deficits. So long as Uncle Sam is borrowing--hogging available cash--long-term rates will most likely stay put. Democrats blame the 10-year rollout of the White House's tax cut. The White House says there would be no borrowing without a war and recession.
Budget politics may have Greenspan squirming when he gives his next report on the economy to Congress. A year ago, amid forecasts of rising surpluses, he said Congress ought to cut taxes. Now, Greenspan may be on the hot seat as Democrats try to change his mind. But he isn't likely to budge. Greenspan's not called maestro for nothing.
Stubbornly high
Although the Federal Reserve has lowered interest rates, long-term borrowing costs are not dropping.
[Complete chart data are not available]
[Chart labels]
10-year note 5.03 pct.
Federal funds rate 1.75 pct.
2001
Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec.
