Greenspan's bet on a boom

[notiCIas]

Greenspan's bet on a boom

A flattening yield curve could signal softness ahead, but the Fed seems to think otherwise.

June 7, 2005: 8:20 AM EDT


NEW YORK (CNN/Money) - Alan Greenspan made himself very clear last night: He does not take the bond market's signal of a slowing economy at face value, and that means he is probably set to keep on hiking rates.

In last night's speech the Fed chairman said that a slowdown in the economy was not necessarily being signaled by low long-term interest rates and a flattening yield curve (that's when long-term rates, which are often considerably higher than short-term rates, are falling closer and closer to short-term rates). Now historically a flattening yield curve has been pretty good at signaling a slower economy ... not infallible, but good.

That's because long-term rates tend to fall when investors see tame inflation pressures and a softer economy, and if markets are efficient, if they accurately discount the future, then those investors in the aggregate are making the correct decisions.

Right now, Mr. G doesn't seem to think so. He's betting on a strong economy, one so strong it's pushing up unit labor costs and is going to experience more inflation if the Fed doesn't prevent that with more rate hikes.

Many of his colleagues seem to agree. And so do many Wall Street economists.

The risk is that the bond market is right and the Fed is wrong about the underlying strength of the economy and that the loss of momentum in manufacturing is a sign of an overall loss of economic energy. Right now it looks like it's a risk the Fed is willing to run.