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Tuesday July 20, 2004 - 00:54:14 GMT
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Greenspan To Stress June A Blip

Greenspan To Stress June A Blip

When the Fed began its "long march" of measured rate hikes in late June, it surely was not anticipating an unequivocally weak set of data for the month of June. And while it claimed the rise in inflation through May was likely transitory, it did not expect June CPI to moderate much.

Should we be concerned that the Fed is making policy decisions (tightening) in an environment with a high degree of uncertainty? Or worse, when it has a poor official forecasting record? Not really. The Fed has underscored its assumptions time and again with conditionality...if wrong it will adjust. So the question for Greenspan on Tuesday, if the Senators have any clue, should be did the Fed get it wrong and hence does it need to change its planned pace for removing accommodation?

June surprised to the downside on nearly every major measure including payrolls, retail sales, corporate earnings (expectations), industrial production and inflation. It would follow that even a measured pace of tightening needs to be more measured...hiking every 12 weeks instead of every 6 weeks.

It is too soon for Greenspan to make a significant adjustment to policy. One month of countercyclical data and news does not end a cycle much less reverse it. More data is needed and since Fed funds are still negative after adjusting for inflation, then removing another 25 basis points of accommodation in August is appropriate (August 10) and carries an acceptably low risk for credit market stability.

If more data is needed, more data is coming...August 06 sees the release of July non-farm payrolls. But even if this report comes in on the weak side of the economic performance spectrum (say south of 100K rise in NFP), then the Fed may have to pause in September, but an August 10 hike would stay.

If there is any lesson in the numbers from nearly three years of recovery, it is the long lags before the productivity well runs dry, consumers are tapped out (loaded down by debt or simply reject the accumulation of goods and services and turn to accumulating financial assets), workers demand higher wages and firms pass on higher input costs (commodities so far) to finished prices. While the Fed has trained its sights on inflation and inflation expectations, its body language and demeanor suggests it has not quite given up on the deflation risk and hence has an expressed need and desire to micro manage the yield curve. It is unique that as the Fed goes after inflation it does so by erring on the side of accommodation and not restraint. In other words the risk of moving too aggressively over inflation (causing a sharp slowdown), outweighs the risk of not moving fast enough. And this is not from the Fed being so darn ahead of the curve either. No it is about downside risk. So tomorrow's performance by Greenspan should be pitched to keeping bond yields from rising by dismissing worries about a sustained rise in inflation, while justifying gradual tightening by noting June slowdown was an aberration.

But like most people, Greenspan is reluctant to discuss one the thing that is really bothering him. Deflation, come liquidity trap, come massive deficit/debt buildup. Fortunately for Greenspan, when he speaks to the bond market through his testimony before the Senate banking Committee on Tuesday (and house Financial Services Committee on Wednesday) he is preaching to the choir. The bond market will hear and accept the Chairman's rendition that June and inflation through May were transitory events until proven otherwise. Bond yields should be little changed, maybe tad lower given the inflation focus. And August 06 is a way off (July jobs) and so it is premature to question much less conclude if Greenspan's winning streak is at an end.

David Gilmore


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