Financial markets across the board rallied on Tuesday as Federal Reserve Chairman Alan Greenspan delivered comments that investors interpreted as signaling the Fed is less worried about inflation.
Mr. Greenspan said in a speech to America's Community Bankers that "the pace of expansion of economic activity has moderated appreciably, in part as tighter financial conditions have had some impact on interest-sensitive areas of the economy," such as home building, vehicle sales, and demand for consumer durable goods.
Under such conditions, he said, "one must remain alert to the possibility that greater caution and weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending."
Market participants saw those words as the clearest sign yet that the Fed is shifting its interest rate policy bias away from tightening and perhaps toward an easier monetary policy.
"There is not much reading between the lines to be done here," said Kenneth Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. "Using loaded words such as 'excessive softness' and 'risks' fits right into bias considerations and, ultimately, into rate cuts. They're coming."
Interest-sensitive financial companies were among the day's rising stars. Thrifts, which Adam Lewis, head bank stock trader at Keefe, Bruyette & Woods Inc. called "the sweet spot" of the sector, were getting yet another boost. Washington Mutual Inc. was up $3.50, or 7.81%, to $48.3125, and Golden West Financial Corp. $4.25, or 7.36%, to $62.
The American Banker index of the top 50 banks ended up 4.64%, and the index of 225 banks rose 6.01%. The Dow Jones industrial average was up 3.21%, and the Nasdaq composite index 10.48%.
Investment banks and money-centers were the biggest winners on Tuesday. J.P. Morgan & Co. and Citigroup Inc. were ahead of the Dow average for most of the day, closing up $13.125, or 9.48%, at $151.625, and $2.9375, or 6.14%, at $50.75, respectively.
Mr. Lewis said the market was anticipating Mr. Greenspan's positive note and "was creeping up as he continued speaking." The trader warned, however, that the rally would probably be short-lived, saying investors' attention will soon return to profit warnings and credit-quality issues.
The market also moved on the possibility of a resolution of the presidential election, according to Nancy Bush, an equity analyst at Prudential Securities Inc. "All of a sudden it doesn't look like the end of the world anymore," she said.
But the market reacted mostly to Mr. Greenspan's clear words, Ms. Bush said. "He indicated that he is aware of the market condition. He is not usually that explicit."
Ms. Bush warned that there is a fine line between Mr. Greenspan's implying that he is attentive to tighter liquidity and an actual reduction in interest rates. "It is too early to read a rate cut into his words," she said. Echoing Mr. Lewis, Ms. Bush also said she expects the current rally to be brief. "It is too early for the Champagne," she said.
Sung Won Sohn, the chief economist at Wells Fargo & Co., said he expects the Fed to remove the tightening bias at the next Federal Open Market Committee meeting but to refrain from slashing rates until well into 2001.
"The financial market is overjoyed with what people think they heard," he said. "Even if the economy is slowing faster than anticipated and the Fed should decide to cut rates earlier next year, the lag until the measure takes effect will take up most of next year."