Among the various definitions of “neutral” found in the Oxford English Dictionary, one informs: “occupying a middle position with regard to two extremes.”
When it comes to monetary policy, neutrality may be a state of mind, however. As for Greenspan’s mind in particular, the maestro isn’t saying where neutrality lies, even though he was directly asked as much today. Is he holding back? Or, if we take him at face value, is he unsure? Not to worry. Even though he can’t (or won’t?) put a number on neutrality at the moment, it will reveal itself eventually. To quote the master from his testimony today in Congress: “We will probably know it when we are there, because we will observe a certain degree of balance which we have not perceived before, which would suggest to us that we’re somewhere very close to what that rate is.”
All of which reminds us of the old quote from Justice Potter Stewart on the issue of defining pornography: Tough if not impossible in the abstract, “But I know it when I see it….”
Similarly, we’re reluctant to say exactly what constitutes a neutral Fed funds rate. But taking a page from the maestro, we’re reasonably sure that when we see a neutral rate, we’ll know it. In fact, we’d go so far as to say that in the absence of a neutral rate, we’d know it too. And as it turns out, we don’t see neutrality in the Fed’s monetary policy at the moment. Neither, we suspect, does the head of the central bank, which is why Greenspan hinted that the price of money will continue to rise, albeit indirectly by noting that the economy remains on “reasonably firm footing.”
CS, on the other hand, can be more direct and confide in you, dear reader, our deepest, darkest thoughts on monetary policy, whereas the chairman of the Federal Open Market Committee undoubtedly feels more constrained. As such, we can speculate wildly, and perhaps incorrectly as to where the monetary equivalent of Switzerland lies. Drum roll please…. It’s somewhere above the current 3.0% Fed funds rate. Whether Greenspan and his colleagues on the FOMC agree is the operative question, and one that gets resolved incrementally, starting with the next confab on rates scheduled for June 30.
Meanwhile, Mr. Market will pay close attention to next week’s releases of May price indexes for clues about what will be dispensed at the June 30 interest-rate-setting rendezvous. For the moment, April’s consumer price index is the latest data installment on the official inflation rate, a measure that tells us that prices generally are rising at 3.5% a year, or exactly 50 basis points above the target Fed funds rate. (Hint, hint.)
Perhaps the bond market agrees that neutrality is above 3.0%, perhaps not. What we can say for sure is that the yield on the 10-year Treasury Note inched higher today for the second day running (a minor miracle given fixed-income trends of late). The intrepid investor considering whether to loan Uncle Sam money for a decade is looking at yield compensation of roughly 3.95%, a hair better than yesterday’s offering but a world, or at least a continent away from the 4.65% that prevailed as recently as late March.
All of this in the wake of what some say was Greenspan’s effort to talk tough with the bond bulls today. As MSNBC noted today after the maestro spoke: “Federal Reserve Chairman Alan Greenspan left little doubt Thursday that the central bank intends to continue pushing short-term rates higher.”
Welcome to the new new age of certainty on the future path of interest rates, and the new new arrogance of the bond market to yawn in the face of certitude.
As for the stock market, renewed talk that the Fed will hike for the ninth consecutive time on June 30 triggered some modest buying. The S&P 500 climbed by half a percent on the day and the Nasdaq Composite did a bit better. What is it the equity traders like in Alan’s latest sermon on the political mount? Perhaps it’s the fact that the stock market believes that raising interest rates is painful but necessary to fend off rising inflationary pressures, and on balance, corporate America will benefit. The bond market disagrees, but then what else is new?
Not much, other than to wait for more data. Let’s start with tomorrow’s import price index for May.
On second thought, why wait when no less a source than the maestro himself suggests the path of least resistance. Indeed, Greenspan mentioned that some real estate markets were getting frothy. Or, as he put it last month, via Bloomberg News: “there is a ‘good deal of speculation’ in real estate markets, and ‘we’re also seeing it in the mortgage market.'”
Although today he blamed so-called exotic financing vehicles, namely, interest-only (IO) mortgages, even CS can connect the dots. And that connection reveals that low interest rates make IO mortgages, along with conventional ones, more attractive, which in turn promotes buying real estate. High interest rates, or, dare we suggest it, neutral rates relative to current rates, would make IOs less attractive, and in the process remove a bit of froth from the property markets.
We know the risks. Heck, we may even know the solutions. Your move, Alan.