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July 25, 1997
In a "relief rally", bonds and mortgages recovered all the ground they lost late last week, and have returned to 18-month lows, 6.42% and 7.625%, respectively.
When a market is worried that something bad is going to happen, and doesn't, the resulting improvement is called a relief rally -- as distinct from a rally in response to authentic good news.
In this case, the market had fainted late last week in expectation of the horrible things Mr. Greenspan might have said on Tuesday, but didn't.
What did he say?
The headlines said "Upbeat", "Positive", and "No Sign of Rate Increase". All true, but the question facing mortgage borrowers (to say nothing of stock market investors) is: how much better is this going to get?
There is a world of difference between "no sign of increase" and the total absence of a sign from Mr. Greenspan that he would consider a decrease. He has been tolerating dangerously fast growth in the hope that productivity and competition would prevent inflation -- not planning to further stimulate growth. Without a cut in the Fed funds rate from 5.50%, it's all but impossible to have a big, additional rally in bonds and mortgage rates. That's the difference between a relief rally and authentic good news.
How and when might the Fed consider a cut in the Fed funds rate? If the economy were to slow down a great deal.
Mr. Greenspan was indeed "upbeat and positive" about the economy -- exactly the reason he is not about to cut interest rates. He noted an "exceptional economic situation", and referred to "a once or twice a century phenomenon". You may choose to focus on the upbeat nature of those phrases, or ponder the chairman's careful description of a transient phase, one which inevitably will return to the non-exceptional conditions which prevailed during the rest of the century.
Way too many people are buying the idea that the economy has achieved a "new paradigm", and that price pressure is dead forever no matter what the growth rate. Some claim that Mr. Greenspan has joined the believers, noting that his testimony this week omitted any reference to the stock market, now 30% higher than it was when he first mentioned "irrational exuberance".
He didn't mention the word "stocks", but he did say: "With the economy performing so well for so long, financial markets have been buoyant, as memories of past business cycles fade with time."
The economy is having a mighty good run, and there is more to come, but the business cycle has not been suspended.
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