ROANOKE TIMES
Copyright (c) 1997, Roanoke Times
DATE: Thursday, February 27, 1997 TAG: 9702270038
SECTION: BUSINESS PAGE: B-6 EDITION: METRO
DATELINE: WASHINGTON
SOURCE: Knight-Ridder/Tribune
THE FED CHAIRMAN made it plain that he is uncomfortable with the stock market, and questioned whether the sharp gains in the last years were sustainable.
For those analysts who expect the Federal Reserve to keep interest rates steady for the rest of 1997, Fed Chairman Alan Greenspan sent a clear message Wednesday: Don't bet on it. And especially, don't bet it by driving stock prices inexorably higher.
In an unusually strong statement, Greenspan made it clear Wednesday that the Federal Reserve was poised to tighten monetary policy if it saw signs that inflation was going to accelerate.
Greenspan signaled that financial market developments, as well as labor costs, are key issues the Fed will be considering in its policy decisions.
The Fed ``continues to see the distribution of inflation risks skewed to the upside and must remain especially alert to the possible emergence of imbalances in financial and product markets that ultimately could endanger the maintenance of the low-inflation environment,'' he said.
Greenspan's mention of potential financial market ``imbalances'' appeared significant, since he specifically questioned whether the recent surge in stock prices was excessive.
Greenspan sent a temporary shock through financial markets in December when he warned against irrational exuberance. However, the effect of those comments was short-lived as the stock market again resumed its climb and set new records.
Greenspan's testimony Wednesday made it plain that he is quite uncomfortable with the stock market. To make sure that markets got his message this time, he decided to wield his rhetorical club again about excesses and swing it again - a lot harder.
Unlike his ``irrational exuberance'' speech in December, he explicitly questioned whether the stock market's sharp gains in the last years were sustainable. He questioned whether financial analysts' expectations for rising profit margins were reasonable and warned that small changes in long-term earnings expectations could have ``outsized impacts on equity prices.''
Greenspan went even further by questioning whether there was too much optimism in the entire financial system.
``Considerable optimism about the ability of businesses to sustain this current healthy financial condition seems to be influencing the setting of risk premiums not just in the stock market but throughout the financial system,'' he said.
As an example, he cited spreads for ``junk'' bonds, suggesting they were too low, as well as the fact that banks have continued to ease terms and standards on business loans.
He warned that financial markets were susceptible to ``waves of optimism'' that can lead to an increase in asset prices that ultimately boost the overall inflation rate for goods and services.
It appears that Greenspan is echoing the famous line of former Fed Chairman William Martin - that the Fed's job is to ``take away the punch bowl'' before the party gets roaring.
Greenspan's comments seem to show concern that the party in the financial markets is starting to get too wild.
By his rhetoric, Greenspan also appeared to be rebuffing comments by some market commentators that the Fed would wait to see the whites of inflation's eyes before it tightens.
Maybe not, Greenspan said.
``Given the lags with which monetary policy affects the economy, we cannot rule out a situation in which a pre-emptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident,'' he said.
The Fed would embark on such a course if it determined the economic expansion would be in peril if it waited, he said.
LENGTH: Medium: 78 lines ILLUSTRATION: PHOTO: AP. Fed Chairman Alan Greenspan (right) huddles withby CNBSenate Banking Committee Chairman Alfonse D'Amato, R-N.Y. color.
Graphic: Chart by AP. color.