View from City Road: Greenspan deserves the trust of the markets

Alan Greenspan is rapidly becoming the central banker's central banker. Yesterday, he did much to defuse the recent turbulence in global bond markets. Against a background of gloom and apprehension in part caused by the quarter-point rise in the Fed funds rate on 4 February, the Fed chairman gently allayed fears of sharp increases in US short-term rates.

His message, in effect, was that the Fed was shifting from an accommodating monetary policy to one closer to neutrality, and that this would pre-empt inflation pressures next year. Contrary to market fears, overall cost and price pressures were currently under control. Though evidence was mounting that the recovery was now entrenched, it was likely to ease back from the steamy fourth-quarter pace.

The markets should be willing to give the Fed chairman the benefit of the doubt, if only because of his track record in operating monetary policy with a foresight lacking in some of his rivals. Two years ago, the Fed chopped Fed funds by a full percentage point to 3 per cent. That easing allowed the US banks to rebuild their balance sheets, and prepare for the recovery. With the task accomplished, Mr Greenspan's message yesterday suggests that this move will be reversed over the next six or nine months.

By midsummer, a Fed funds rate of 3.75 per cent seems possible, with a step up to 4 or 4.25 per cent likely by the end of the year. These are far from panic measures. The Fed is forecasting growth of 3 to 3.25 per cent in the year to the fourth quarter, and a rise in inflation to about 3 per cent. An increase in nominal rates of this order would accord with Mr Greenspan's view that 'real short- term rates are more likely to have to rise than fall'. Since they are currently under 1 per cent (against 3 per cent in the UK), that should hardly come as a surprise.

Measured against this, the hedge-fund inspired sell-off in the US bond market may have been an over-reaction. Indeed, Mr Greenspan expects long-term rates to fall back as the expansion cools from a fourth-quarter rate that now looks an annualised 7 per cent.