His remarks sent short- and long-term bond yields up sharply and clipped the stock market.
Greenspan's comments to bankers meeting here deflated market expectations built up in recent weeks by government statistics showing a significant deceleration in the economy. Many investors have come to assume that the Fed would lower its benchmark short-term interest rate soon to help revive economic growth and guard against a recession.
But the Fed chief, speaking to reporters after a closed-door session with executives at the American Bankers Assn.'s annual International Monetary Conference, said that while "the probabilities . . . of a recession have edged up as one would expect" as business activity has slowed, key aspects of that slowdown are "clearly desirable."
In particular, he indicated that a reduced pace of activity stemming from the buildup of business inventories last year was "inevitable." Some companies have cut back production while waiting for goods already on shelves at the wholesale and retail level to sell.
Although Greenspan acknowledged that "the evidence is very clear that the degree of slowing down is very pronounced, and we are in a sluggish environment," he also said that "the probability of a significant inventory recession in the intermediate future has decreased very significantly" because companies have acted quickly to more closely match output with demand.
While the Fed chief's comments suggested he is basically optimistic about the economy's prospects, he caused a rout in the bond market--where many market players had made substantial bets that the central bank would ease credit as early as July.
Traders who had locked into longer-term bond yields in recent weeks turned and sold on Wednesday, sending yields surging. The yield on one-year Treasury bills rocketed to 5.73% from 5.56% on Tuesday, while the 30-year Treasury bond yield rebounded to 6.56% from 6.51%.
"The market is extremely vulnerable [to] any fear or any questioning at all" that the Fed won't cut rates, said Chris Carroll, head U.S. bond trader at Nomura Securities International.
"The market was pricing in such conviction two days ago that the Fed would ease," Carroll said. Now "people absolutely have to change their exposure [to the market] and do it quickly. It is such an emotional move."
The Fed last cut short-term interest rates in September, 1992. It increased rates seven times between February, 1994, and February, 1995, in an effort to slow economic growth and keep inflation subdued.
Separately on Wednesday, Fed Gov. Edward Kelley, speaking before a business group in Alabama, said he doesn't expect the economy to rebound markedly in the third quarter. But he also said he sees no "killer imbalances" in the economy that would produce recession.
Greenspan and Kelley's remarks contrast with those of Fed Vice Chairman Alan Blinder on Tuesday, who said he is worried about the recent sharp slowdown in the economy. He said he is "more concerned now about the downside [risk of recession] than the upside" risk of a fast turnaround and higher inflation.