Alan Greenspan's self-edits tamp down mortgage rates

By Greg McBride, CFA
Bankrate.com
July 26, 2004

What a difference one year can make. Alan Greenspan's appearance before Congress, the twice-annual Humphrey Hawkins Testimony, was a marked contrast from that of last summer. Greenspan's comments were consistent with recent statements and produced a subdued response from financial markets.

When Alan Greenspan gave the same testimony last year, the economic landscape was different. The Fed had just cut rates for the 13th, and what would prove to be the final, time. The economic term on everyone's lips was deflation. Long-term bond yields had plunged to the lowest levels in more than 40 years as investors flocked to the safety of Treasury securities amid concern about deflation, a floundering job market, the ongoing threat of terror, and heightened geopolitical tensions surrounding Iraq and North Korea. The Fed had been cheering these investors on, speaking of resorting to "unconventional methods" to thwart deflation if needed.

This was Fedspeak for buying up long-term Treasury securities in an effort to pump more money into the economy, and it sparked considerable front-running by investors looking to profit if the Fed indeed resorted to such a tactic. The corresponding decline in Treasury yields and mortgage rates set off an unprecedented wave of mortgage refinancing that provided fistfuls of cash to homeowners, and a valuable economic stimulus when it was spent just as quickly.

Once Greenspan went before Congress in July 2003, things quickly turned into a summer of discontent for bond investors and mortgage shoppers. Greenspan was perceived to be backpedaling from his comments about using unconventional methods and a stampede out of Treasury notes ensued. Yields on Treasury securities and mortgage rates both skyrocketed in the weeks that followed Greenspan's testimony, with the average 30-year fixed-rate mortgage jumping to a 12-month high of 6.43 percent on Aug. 6, 2003, after being at 5.31 percent just prior to the final Fed rate cut at the end of June.

The Federal Open Market Committee's communication model seemed to undergo an immediate makeover after that fiasco. The FOMC's post-meeting statements began to contain specific terms designed to prepare markets for the eventuality of higher rates, with the phrase about keeping interest rates low "for a considerable period" inserted as of the Aug. 12, 2003, meeting. The "considerable period" phrase was maintained through the end of 2003 but has since migrated to "patient" during the first quarter of 2004, and finally the current buzzword "measured" that has been in place since May.

This carefully orchestrated message would be an integral part of Greenspan's Congressional testimony July 20-21 as he reiterated the intent to raise interest rates at a measured pace, while also professing the Fed's vigilance against inflation. By pledging to remain on guard against inflation by raising rates more aggressively if needed, this is another departure from the scenario of one year ago when deflation was the prevailing concern. Despite evidence of slower economic growth over the past month, Greenspan dismissed this as temporary and instead conveyed a confidence in continued economic growth and the need to raise interest rates in a gradual manner.

Unlike one year ago, Greenspan chopped several paragraphs from his prepared comments that could have been unsettling to the bond market. Not that any of this would have been a revelation to bond investors, but when Alan Greenspan talks about bonds sustaining capital losses as interest rates rise or reversing the capital gains enjoyed on bonds, it is likely to have a negative effect on the bond and mortgage markets. While the comments were part of his prepared remarks and he asked that they be included in the record, it is noteworthy to exclude comments from a speech where every word is parsed with excruciating detail.

Had he chosen to speak those words, there is a good chance mortgage rates would have jumped in the days that followed.

Much of the work of Fed policy takes place between meetings through speeches and public statements, and Alan Greenspan's latest Congressional testimony was the latest opportunity to publicly communicate the Fed's stance. The modest reaction to the comments is evidence of the improved efficiency and consistency in delivering the message.

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