Inflation, Bonds, and the Fed

Alexandra Twin from CNNMoney has perhaps the clearest description of the bond problem:

Greenspan’s much-discussed “conundrum” as to why yields on long-term bonds have not risen despite the rise in short-term interest rate certainly woke up the bond market: Treasury bond prices tumbled for three sessions, pushing the yield on the 10-year note up to 4.26 percent from 4.08 percent. Treasury prices and yields move in opposite directions.

Rachel Beck from the AP writes about how the bond market rally was surprising everyone, including the Fed:

“For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum,” Greenspan told the Senate Banking Committee. “Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.”

Ros Krasny from Reuters shows that the Fed is unlikely to change its policy of measured increses in interest rates. The conclusion is that the Fed is very concerned with the bond market:

Greenspan’s concern about low long-term yields means the tail could wag the interest rate dog over the next few months, he said.

Normally fixed income dealers use the central bank’s views on Fed funds to make trading decisions in bonds. But the reverse may be taking place.

“The Fed does not control the long end of the curve but they find (current levels) hard to justify, so bond yields complicate matters a bit. If the 10-year yield (US10YT=RR: Quote, Profile, Research) rises back to 4.5 percent there is more chance the Fed will pause the funds rate at 3.25 percent,” Ruskin said.

My conclusion, which is based on a lot of reading, is that no one has any idea what’s going to happen to the bond market.

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