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S. Balakrishnan

THE question nagging global bond markets is `Will history repeat itself?'

History is 1994, when the US Federal Reserve doubled interest rates from 3 per cent in a short span of time in response to faster growth and the (consequent) threat of higher inflation. The Fed Chairman at the time is the very same Mr Alan Greenspan who today strides world financial markets larger than life.

Bond traders have been spooked by just two bits of data recently — firstly, February's non-farm payroll of 308,000, and the CPI headline inflation was 0.5 per cent, hardly tempered by the 0.4 per cent rise, ex-food and energy. Previous months were marked by a divergence between the behaviour of overall CPI and its core, assuaging fears about the general price level and calming the bond market.

The latest numbers' deviation from past patterns aroused hitherto subconscious worries about inflation. After all, commodity prices have been on a binge for quite some time. The riddle was how and why they did not show up in the final price indices. Various explanations were trotted out: the remarkable productivity performance of the US economy, competition, excess capacity, surplus labour, etc.

The verdict of the members of the Federal Open Markets Committee (FOMC), which sets the US interest rates, was unanimous — rates could stay low for a "considerable period" and it could be "patient" in changing the current soft interest stance. There was an amazing convergence of thinking among both the right and left-leaning members of the FOMC. Indeed, at the last FOMC cut, one of the members of the conservative group actually argued for 50 bps instead of a 25 bps cut.

"One swallow does not make a summer" seems to be what the FOMC feels. It is hardly fazed by the much stronger than expected employment and CPI numbers. Mr Ben Bernanke, possibly the most influential FOMC member after Mr Greenspan, was unequivocal that there was enough slack in product and labour markets to keep inflation in check. The opposite view — if it could be called that — in the FOMC was itself very mild: that the present low level of rates was exceptional and could not be indefinitely stayed.

The big event of this week is going to be Mr Greenspan's Congressional testimony on Wednesday. Reading his words and lips will dominate the minds and actions of analysts and traders.

If he does talk about the economy, Greenspan is likely to take heart at the momentum appearing on the jobs front — indeed his recent speeches reflect confidence that there would be a turnaround soon, which is borne out in the latest figures. He will see the trend continuing, if not at the same pace as last month.

Mr Greenspan's message on inflation will be the most closely watched. It may not give much comfort to inflation hawks. More evidence of continuing and sustainable price increases is needed before switching to an aggressive policy of raising rates. However, the Fed will not be found wanting if prices do pose a risk.

Back in 1994, the Fed acted to pre-empt inflation but inflation did not, in fact, surface at all and kept falling throughout the late 90s amidst strong growth.

Bottomline?

2004 is different from 1994. Greenspanspeak will unsettle bonds, but is unlikely to translate into a Fed tightening all that soon and easily.

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US interest rates: 2004 is not 1994

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