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Greenspan speaks, Wall Street decides?

Posted: Friday, June 13, 2003

NEW YORK (AP) Sometimes it just takes a single word out of Alan Greenspan's mouth to convince Wall Street of the Federal Reserve's next move.

Just look at what's happened in the last week: Greenspan mentions that the Fed may take out ''insurance'' to prevent economic weakness and deflationary pressures. Financial markets translate that to mean another cut in interest rates is imminent.

But is that what Greenspan meant? It might not matter.

''If market expectations of a rate cut become sufficiently well-entrenched, the Fed will have little choice but to deliver,'' Louis Crandall, chief economist of Wrightson ICAP, wrote in a report to the firm's clients this week.

The Fed's main tool to influence the economy is the federal funds rate, the interest that banks charge on overnight loans. It is currently at a 41-year low of 1.25 percent after 12 rate cuts since early 2001.

Speculation that rates will drop again rose last week after Greenspan, speaking via satellite to a banking conference in Berlin, said the Fed was prepared to take out ''insurance against economic weakness'' to prevent inflation from declining further.

Falling prices have been of particular concern to the Fed in recent months, and while Fed officials have said there is little chance of crippling deflation taking hold, Greenspan noted in his talk that the Fed's lack of experience in taming it requires a ''wider firebreak.''

''If you are thinking of a firebreak, you obviously think there must be a fire,'' said Christopher Wolfe, equity market strategist at J.P. Morgan Private Bank.

Investors are now more and more certain that rates are coming down at the Fed's June 24-25 policy-making meeting. Bond yields have plunged the yield on 10-year Treasury note is now at a 45-year low while stocks have gone up on hopes of a cut of at least a quarter of a percentage point.

And with Wall Street betting on a Fed rate cut, it could well very well happen.

That's because Fed has made a concerted effort to not throw anything unexpected at financial markets.

So not cutting rates could potentially panic Wall Street. And the last thing the Fed wants to do right now is roil already fragile investors, who are just starting to be more comfortable with putting money into the stock market again.

''If the market has persuaded itself by June 25 that the only question is whether the rate cut will be 25 basis points or 50, an unchanged policy stance would constitute a nasty surprise of the first order,'' Crandall said.

Still, not everyone is so convinced that another rate cut is really necessary, considering some recent economic data.

Take the May jobs report. While the unemployment rate did jump to a nine-year high of 6.1 percent, the rate of job losses slowed. Businesses cut just 17,000 jobs last month, following a revision in April in which no jobs were lost, according to the Labor Department.

Also positive was the pickup in hiring at temporary employment firms, which saw an increase of 58,000 jobs. Economists closely watch that industry, because it can signal when companies may begin to hire permanent, full-time workers.

Another report by the Institute for Supply Management found that manufacturing business activity declined last month, but at a considerably slower rate.

There's also the anticipated economic stimulus from the new $350 billion federal tax cut, which could start kicking in this summer.

''When all is said and done, the fundamentals don't argue for a June rate cut,'' Crandall said.

But with Wall Street so sold on a rate cut, the Fed may have no choice but to give investors what they want.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org



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