The Hindu Business Line : Weak data unlikely to worry Greenspan

IT'S decision time again at the Federal Open Markets Committee (FOMC), the interest rate setting body of the US Federal Reserve. What it does and says has implications, not only for the American economy and financial markets, but also for the rest of the world. If its message is that interest rates must go up, global bond yields will rise.

A benign stance will, on the other hand, boost bond prices everywhere. Good or bad, global financial markets take their cues from the Fed. There is an amazing degree of correlation between movements in US bond yields and those in other markets. All, therefore, are on a heightened state of alert on the eve of Fed meetings.

The FOMC is on a sticky wicket. Preliminary estimates of GDP in the second quarter show growth at 3 per cent - a significant slowdown compared to the previous quarter when it was 4 per cent +. Consumer spending, which accounts for two-thirds of the economy, had also slowed. Discretionary income, after meeting necessities, declined because of high gasoline prices.

The disappointing GDP report was followed by a shocker: job creation in July was only 32,000 — a pittance for the gigantic US economy. Even the figures for May and June were revised downward, indicating unemployment remains the bane.

On top of these gloomy data is the relentless climb in oil prices to near $45 as this is being written.

In a recent testimony, Mr Alan Greenspan, Chairman of the US Federal Reserve, reassured his audience that the economy had hit a "soft patch" but it was "temporary". Will the latest data change his mind?

The Fed is committed to a "neutral" level of interest rates. The danger of deflation, which was very much on the agenda at this time last year, has disappeared. Growth, though not extraordinary, is not unsatisfactory. The Fed's ultra-accommodative stance is no longer needed. The last increase of 25 bps was but a little step in this direction. The question is what is the "neutral" rate. Greenspan says we won't know till we get there! A setback to the economy would obviously mean pushing back the timetable for rate increases.

Inevitably, markets must look to the post-meeting statement to figure out the Fed's thinking. There is little reason to believe that Greenspan will revise his recent views that the current weak data is only a blip. The FOMC is likely to reiterate that the economy is moving forward and will continue to see gains in the labour market with inflation remaining at bay. There will be no change in its gradualist approach to raising interest rates. Bond yields should perk up in the aftermath of the Fed's soothing words on the outlook for the economy.

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