Wall Street awaits Greenspan's wisdom on growth

WASHINGTON -- How fast is too fast? That's the question the financial world wants Federal Reserve Chairman Alan Greenspan to answer today when he makes his semi-annual report to Congress on the state of the economy.

During his last appearance in February, Greenspan sent stocks and bonds plunging after he suggested the Fed didn't need to cut interest rates further because the then-lagging economy was poised to take off. The Fed "would certainly welcome faster growth, provided it is sustainable," he told Congress.

Faster growth he got. Economists estimate the economy grew at a sizzling 4 percent to 5 percent annualized rate in the second quarter that ended 2 1/2 weeks ago -- even as the Fed held steady at 5.25 percent its benchmark federal funds rate on overnight bank loans.

And even though Treasury bond yields, mortgage rates and other borrowing costs have risen since February, there are few signs of a slowdown so far. Just Wednesday, for example, the Commerce Department reported new housing starts unexpectedly rose 1.3 percent in June as starts of single-family homes reached their highest level in more than two years.

What investors want today is a clear signal from the Fed chairman about whether the Fed feels the need to boost the fed funds rate to prevent the economy from overheating, or if the central bank can stand pat in the expectation a second-half slowdown will eventually arrive.

Don't count on that kind of clarity, however. For one thing, it's not his style. "Knowing Alan Greenspan and having followed him as closely as I have over the years, I predict he will say absolutely nothing" about a possible shift in interest rates, said Senate Banking Committee Chairman Alfonse D'Amato. "He won't give any indication."

The Fed chairman also knows that with inflation showing no signs of accelerating, any aggressive move by the Fed to slam on the brakes this summer will, at best, slice into corporate profits and at worst trigger a recession. At the same time, a blunt message from Greenspan that the Fed won't raise rates could cause inflation-wary bond traders to send Treasury prices skidding, which would exacerbate the turmoil in stock and bond markets of the last two weeks.

"It's a tough call," said economist Tom Carpenter of ASB Capital Management in Washington about the need for raising rates. "The big picture is that U.S. economic fundamentals are very, very good."

Indeed they are. Unemployment is at a six-year low of 5.3 percent, wages have started rising again after a long pause, though not enough yey to spark an inflation surge as consumer prices rose only 0.1 percent in June. "That's exactly what we want," said Alan Blinder, the former Fed vice chairman.

Greenspan's challenge is to keep it going. On Tuesday the Clinton administration revised its economic forecast, predicting the economy will grow 2.6 percent this year. In February, Greenspan said the economy's potential, the growth it can sustain without pushing up inflation, is somewhere between 2 percent and 2.25 percent per year.

He's likely to be quizzed by members of the Senate Banking Committee about why a faster growth rate can't be accepted as long as there are few signs of inflation -- like there are now. In addition to June's minimal rise in consumer prices, the producer price index rose just 0.2 percent last month.

Analysts say it's not that simple, though. They point to the Labor Department report showing that in addition to a larger-than-expect increase of 239,000 jobs in June, average hourly wages rose during the month by the largest amount on record.

What that says is "at least for now, the faster growth of wages and salaries has yet to be transmitted to other goods and services," said John Lonski, senior economist at Moody's Investors Service.

Possible reasons for that are greater output from workers and a slowdown in the growth rate of health insurance and other fringe benefits, which allow employers to fatten pay checks. "Its important from the inflation side that one focuses on the overall costs to firms -- compensation, not wages," said Joseph Stiglitz, chairman of the president's Council of Economic Advisors.

Still, because the second quarter compensation numbers won't be released until the end of this month, it's not clear whether the trend to lower fringe benefit costs has been maintained.

Greenspan also doesn't know just how strong the economy is in the third quarter. While the Fed chairman loves to crunch numbers, the statistics he has to work with so far offer no clear indication.

Factory orders were up in June, as was the widely watched National Association of Purchasing Management survey of business conditions. Industrial production increased for the third month in a row in June, while business inventories fell, a sign manufacturers are having trouble keeping up with consumer demand.

The increase in Americans' wages, meanwhile, suggests consumers still have money to spend. But consumer debt continues to set records most months, credit card delinquencies has reached a 15-year high and car sales haven't been anything to write home about.

"I do think there'll be a slowdown," said Blinder, who's now back teaching economics at Princeton University. "But it will be caused by market (interest) rates, not the Fed's rates."

That may explain why Greenspan and other members of the interest rate-setting Open Market Committee decided against raising rates at their last meeting two weeks ago.

The markets reacted violently, however. Bond yields shot up and stocks fell when, two days later, the June employment report was released. Greenspan "certainly did take something of a jolt when he failed to tighten in July and then we got the big jump in employment," said Fed-watcher David Jones, an economist at Aubrey G. Lanston & Co. in New York.

The general consensus among economists and investors is that if the July employment numbers exceed expectations when they are released early in August, the Fed will raise rates or watch the stock and bond markets tumble.

"We are going to get some unpleasant surprises down the road, and I think they will have to take out an insurance policy," said Sung Won Sohn, chief economist at Norwest Bank in Minneapolis.

But the timing is tricky, said Jones. The Fed's next meeting is Aug. 20, right between the Republican and Democratic conventions, and the meeting after that is Sept. 24, just over a month before the presidential election. Fed officials may not want to become part of the political debate.

All of this explains why the financial world isn't likely to get the answers it seeks.

Copyright 1996
Provided by ProQuest Information and Learning Company. All rights Reserved.