Greenspan's Rate Hike Sparks Market Jitters and Preserves Prestige of US Central Bank

Strategic Insights -

In a surprise move, Alan Greenspan, chairman of the Federal Reserve, raised short-term interest rates for the second time in two months, sparking market jitters and questioning the central bank's prestige. The decision to raise the federal funds rate by another quarter point, to 3.5 per cent, has alarmed investors, causing the US stock market to lose nearly 90 points. The bond market also tumbled, sending long-term rates over 7 per cent for the first time in 10 months. The market's reaction has raised concerns about the administration's handling of the economy, particularly President Clinton's alleged pressure on Greenspan to keep rates low.

Key Takeaways:

  • Greenspan's rate hike has sparked market jitters, causing the US stock market to lose nearly 90 points and the bond market to tumble.
  • The decision to raise short-term interest rates has raised concerns about inflation, despite most economists not seeing inflation as an issue.
  • Greenspan's handling of the rate hike has been criticized, with some arguing that he has confused the markets by talking about inflationary expectations.
  • The Fed's decision to publicly announce the rate hike after only revealing it to seasoned Fed watchers has also been questioned.
  • The rate hike has added pressure on Greenspan to raise rates higher and more speedily, with some economists predicting a rise in the federal funds rate of half a percentage point by mid-May.
  • The White House's political ineptitude has been cited as a contributing factor in the market's reaction to the rate hike.
  • Greenspan's decision to raise short-term interest rates has also been seen as an attempt to ward off attempts to erode the authority of the Fed.

Statistics:

  • The US stock market lost nearly 90 points after the Fed's decision.
  • The bond market tumbled, sending long-term rates over 7 per cent for the first time in 10 months.
  • The federal funds rate has been raised by a quarter point, to 3.5 per cent.
  • First-quarter growth is expected to be less than half of the fourth quarter's blistering 7.5 per cent.
  • January and February data for industrial production, retail sales, and housing starts show a decrease in growth.

Sources:

  • NY: 'Greenspan Tightens -- Warns of Inflation', The Financial Times
  • 'The Fed Misreads the Market', The Wall Street Journal.