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February 27, 1998
Mr. Greenspan's testimony on Tuesday has the New Paradigm Pollyannas and the Deflation Disciples in full retreat. T-bonds are trading this morning at 5.99%, up a quarter percent from the December-February range, and low-fee mortgage packages may not survive the day near 7.25%.
Once again, economic news showed no sign of the Asian troubles spreading to the US: existing home sales roared ahead at a 4.5 million annual clip, and orders for durable goods rebounded .7% in January.
Until Tuesday, the optimists in the bond market had hoped the wreck in the Western Pacific would slow the American economy enough that the Fed would ease.
Mr. Greenspan dumped this theory on its head. He's scanning the horizon for an Asia-caused domestic slowdown, but not so he can ease. He hopes the slowdown -- if it appears -- will save him from having to raise rates.
The sentence that did the deed: "The key question going forward is whether the turmoil in Asia will be sufficient to check the inflationary tendencies that might otherwise result from the strength of domestic spending and tightening labor markets." If he says it's the key question, it is.
Another paragraph that didn't help at all: he and his colleagues encouraged a passive tightening all year long last year, and only the Asian mess has held them back from overt moves.
Here's how passive tightening works: the Fed funds rate has been steady at 5.50% since last March, but since the inflation rate has fallen a half percent in the last year, the "real" Fed funds rate has risen. Many observers noted the increase in the real rate last year, and in the prevailing warm cloud of optimism assumed it was accidental.
On Tuesday, the Chairman for the first time confirmed -- emphasized -- that this half-point rise in the real Fed funds rate was absolutely intentional by the Fed, and the rise was "reassuring" to its members.
Mr. Greenspan did not describe a fragile economy teetering on an Asian brink, but a very strong one -- dangerously strong. He continued his labor market mantra: for the last four years, America has created a million jobs a year in excess of the growth of the work force; and labor market conditions are the tightest since statistics were first kept in 1970. "Unsustainable."
The search for an Asian slowdown is a bigger deal each week. If we don't find it soonŠ good Dr. Greenspan just showed us the needle.
Next labor market check: Friday March 6.
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