June 3 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan suggested that U.S. economic growth is poised to accelerate in the second half and that the central bank has room to cut rates from a 41-year low because inflation is under control. ``The marked moves in the stock markets in recent weeks and especially in the credit markets is suggestive of a fairly marked turnaround,'' Greenspan told an international monetary conference in Berlin. ``The chances of inflation re-emerging in the near future are quite small.'' While the pickup ``has not yet begun,'' the Fed chairman said, recent government and industry reports show the economy ``stabilized'' last month. Rising stock prices and a narrowing of corporate bond yields over Treasuries may signal faster growth ahead. A $330 billion tax-cut plan that takes effect July 1 may boost consumption and lead to lower unemployment, he said.
``If the data between now and the end of June show a further weakening in the economy, or signs of further deflation, the Fed will ease'' interest rates, said Brian Wesbury, chief economist at Griffin, Kubik, Stephens and Thompson Inc. in Chicago. ``Every piece of data has now become hyper-important. That goes for every weekly piece of data, every blip in consumer confidence, and every move in the stock market.'' U.S. Treasuries rose in New York, sending two-year and five- year note yields to the lowest since the early 1950s, on speculation the Fed will cut the benchmark interest rate from 1.25 percent this year. The yield on the two-year dropped as low as 1.19 percent, the lowest in at least 53 years and a sign that traders are betting a rate cut within six months, analysts said.
`Makings of a Turnaround'
Over the past three months, the Standard & Poor's 500 stock index has risen 16 percent, and the average yield investors demand to own corporate bonds relative to Treasury securities has contracted more than half a percentage point this year to 1.3 percentage points. A narrower spread suggests investors are willing to take on more debt, confident that it will be repaid. ``What we have is the makings of a turnaround in economic activity which in the past has almost always been signaled by an improvement in financial conditions,'' the Fed chairman said. Normally, a pickup in growth is accompanied by accelerating inflation. That's not happening now, Greenspan said, suggesting the central bank won't raise interest rates at the next policy meeting June 24-25. The 1 1/4 percent note due in May 2005, the most sensitive to changes in expectations for the Fed's target rate, rose 3/16 point, pushing its yield down 10 basis points to 1.20 percent at 4:36 p.m. in New York. The 3 5/8 percent note maturing in May 2013 rose about 5/8 point, pushing down its yield 7 basis points to 3.34 percent.
Caveats
Greenspan cautioned that the economy isn't yet showing evidence of faster growth. What makes him optimistic, he suggested, is a ``reversal'' since the end of the Iraq war of conditions constraining growth. Oil prices have fallen by almost a third, consumer confidence grew at the fastest pace in a year last month, and manufacturing is picking up. A report yesterday showed that the Institute of Supply Managers' manufacturing index rose for the first time this year in May. ``It is too early to get any real fix on the American economy in the period ahead,'' Greenspan said. ``We do know that the economy did weaken in March and April; the data from May to date suggests that it stabilized.''
Wall Street Forecasts
Forecasters at Goldman, Sachs & Co., Lehman Brothers Inc. and Bear, Stearns & Co. in the past week have all cited signs of growth. Changing a tone it's held since late 2000, New York-based Goldman Sachs said yesterday it sees a ``meaningful upside'' potential for its U.S. economic outlook because of ``improved financial conditions and a tax cut that was a bit larger than we had expected.'' Senior economist Ed McKelvey said there hasn't been enough improvement to justify raising the firm's 2.2 percent annual growth forecast, which is below the median estimate. The Fed chairman noted that economic forecasters predict third-quarter growth of about 3.5 percent, which matches the median estimate in a Bloomberg News survey. That's faster than his forecast, Greenspan said. Still, the $330 billion in tax cuts passed by Congress last month and continued gains in output per hour by the U.S. labor force should help propel economic growth, he said. Corporate Profits Rising stock prices and falling yield spreads make it less expensive for companies to invest, said Mickey Levy, chief economist at Bank of America Securities in New York. The recent performance of financial markets is ``a reflection of recent improvements in corporate profits and cash flows and they are anticipating further improvement.'' Hewlett-Packard Co., the world's No. 2 computer maker, today said it will meet analyst forecast for second-half sales and profit. The Palo Alto, California-based company expects sales to rise 5.8 percent to $36.6 billion while earnings per share, excluding some costs, will jump 63 percent. ``While we do see signs of stability in the U.S. economy, we don't see signs of a pickup yet,'' Chief Executive Officer Carly Fiorina told analysts at a meeting in New York.
Tax Cuts
The tax cut may help, Greenspan said. The Labor Department on Friday may report that the unemployment rate rose by a tenth of a percent to 6.1 percent last month, based on the median forecast. The U.S. economy lost 481,000 jobs in the fourth and first quarters when the economy expanded at annualized quarterly rates of less than 2 percent. ``Fortuitously, this particular cut in taxes is happening at the right time,'' Greenspan said. Americans are likely to increase spending, and that should lead to improvement in what has been an ``exceptionally weak'' labor market. ``But I must emphasize at this moment that these are forecasts,'' Greenspan said. ``To get anywhere close to the type of increases that economists are forecasting for July, August and September on average, the monthly data -- indeed the weekly data - - have got to start moving in a positive direction fairly quickly.''
Deflation
Greenspan said the Fed is concerned about ``corrosive deflation,'' a general decline in prices that feeds on itself. Falling asset prices in turn bring down spending as people feel less wealthy. That leads to contracting profit margins ``and a type of weakness which we all at least theoretically conclude is far more of a concern than inflation,'' he said. For that reason, Fed officials have recently been talking about deflation in many of their speeches, ``because we've been interested in getting a dialogue going'' Greenspan said. While there's a ``very low probability'' of deflation taking root in the U.S., the Fed's lack of experience in dealing with the phenomenon means ``we need a wider firebreak,'' Greenspan said. That suggests the Fed ``would be far more inclined, as we have had over the last couple of years, to be taking out insurance against economic weakness,'' he said. With inflation low -- consumer prices outside of food and energy are up just 1.5 percent over the past year -- ``the cost of addressing it is very small indeed.'' Investors took that as additional evidence the central bank is in no hurry to raise rates, and might be forced to lower them. ``The effects of deflation are such that the Fed must fight to make sure it doesn't happen,'' said Christopher Low, chief economist at FTN Financial in New York. //www.bloomberg.com