Market awaiting explanation from Greenspan on Fed's inflation stance in healthy economy.

WASHINGTON -- Federal Reserve chairman Alan Greenspan faces a tough task of explaining what the Fed is up to when he testifies today before the Senate Banking Committee.

Officially, things seem to be going along just fine. Greenspan, in a statement on Friday, said, "The U.S. economy has recently been experiencing the ideal combination of rising activity, falling unemployment, and slowing inflation."

But the bond market wants to know what lies ahead, and here the picture is not so clear.

Some analysts are saying the economy is taking on a softer tone, in part because of the Fed's four moves so far this year lifting the federal funds rate to 4.25% from 3%. If the economy is slowing, the Fed's need to squeeze it to head off inflation is presumably diminished.

Other economists argue that production of goods and services is still too strong, setting the stage for at least a mild upturn in inflation in 1995 that will require more restraint by the Fed.

"We're getting mixed signals, and there's fuel for every argument," said Stephen Slifer, senior vice president for Lehman Brothers.

As a rule, Greenspan does not tip his hand and tell the bond market where he and his colleagues are likely to take interest rates in the months ahead. But because he will be presenting the Fed's semiannual monetary policy report to Congress, he will release the central bank's tentative forecasts for economic growth and inflation in 1995.

Lately, the economy's future direction has been especially difficult to predict because it is not clear what is going on now.

Last month, there was evidence that the economy was in the process of slowing down. Rising interest rates were dampening home mortgage applications, and retail sales fell in March and April.

Then the Labor Department issued the June employment report, which showed a surprising surge of 379,000 nonfarm jobs while the civilian jobless rate stayed unchanged at 6.0% -- a rate that many economists consider close to full employment. Even vice chairman Alan Blinder, President Clinton's new appointee to the Fed, has said he believes rising wage pressures are likely to follow if unemployment goes much below 6%.

Still, in the last few weeks, perceptions of a softening economy have taken hold again. Retail sales rose 0.6% in June, and the Commerce Department showed that business inventories bulged 1.1% in May. The reports suggested that businesses were finding themselves stuck with unsold goods as consumers backed off from their earlier buying binge.

"There is growing evidence that economic momentum is softening," said Carl Palash, chief economist for MCM Money Watch.

Economists expect growth in gross domestic product in the second quarter will be higher than the impressive 3.4% gain recorded in the first three months of the year. But they add that much of the growth came from inventory-building, which means final demand for goods and services was actually weak.

Palash estimates that GDP grew 4.5% in the second quarter, but personal spending -- which accounts for two-thirds of GDP -- grew only about 1%, he said.

Slifer figures GDP swelled by 4.7% in the second quarter, but that "grossly overstates the degree of strength in the economy," he said. "Retailers and wholesalers went merrily along and ordered stuff, and soon they experienced a steep drop in consumption."

Slifer predicts growth will slow sharply to 1.8% in the third quarter, and he does not see any further Fed tightening for the rest of the year. That is a prediction that is at odds with the thinking of most Wall Street analysts, but Slifer says he believes Fed officials themselves are counting on things cooling off.

He pointed out that in the minutes of the May 17 meeting of the Federal Open Market Committee, the staff forecast "suggested that economic activity, after rebounding from disruptions caused by adverse weather conditions earlier in the year, would expand in the second half of 1994 at a rate close to the growth of the economy's potential." Most economists figure the economy's potential, or noninflationary, growth rate is in the range of 2.5% to 3%.

However, Richard Berner, chief economists for Mellon Bank in Pittsburgh, said the economy does not appear to be slowing quickly enough from a rate of more than 5% in the last three months of 1993 and more than 4% in the first half to block the Fed from tightening credit further.

Further, some analysts believe the economy will get a boost next year as exports pick up to Europe and Japan as both regions experience upturns in growth.

"The Fed can't take the chance that inflation will stay low, and that's the critical issue," Berner said. "As much as the Fed would like to make policy based on some indicators, unfortunately there are not any real credible indicators. They're left with having to make policy based on judgment, and their own forecast and sense of where the economy is going."

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