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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: ild who wrote (56338)	3/20/2006 8:49:56 PM
From: ild	Read Replies (1) \| Respond to of 110194

Bernanke Delves Into Market Puzzle Fed Chairman Addresses What Low Long-Term Rates May Mean for Policy Moves By GREG IP March 21, 2006 Unusually low long-term interest rates could require the Fed to keep the short-term rates it controls higher -- or lower -- than normal, Federal Reserve Chairman Ben Bernanke said. It all depends on what is keeping long-term rates down. Tackling one of the biggest current puzzles in financial markets, Mr. Bernanke turned to a theory he popularized a year ago to suggest that the Fed ought to keep rates lower than it normally would. He said a glut of world saving -- a result of high saving and weak investment demand across many countries -- might be keeping long-term rates unusually low. If that is so, then the "neutral" short-term interest rate -- one that neither stimulates nor restrains spending -- will also be lower than normal, Mr. Bernanke said in a speech to the Economic Club of New York last night. Mr. Bernanke has discussed before what he has dubbed a "global saving glut," but his remarks yesterday were the most explicit in explaining what the phenomenon means for Fed policy. However, Mr. Bernanke said other explanations for low long-term interest rates, such as a shortage of long-term bonds or strong demand from pension funds, would require the Fed to set its key short-term rate target higher than normal. Thus, "the implications for monetary policy of the recent behavior of long-term yields are not at all clear-cut," he concluded. The Fed, he said, must watch bond yields closely but "only in tandem" with other financial-market prices, data on growth and inflation, and "a goodly helping of qualitative information." Since June 2004, the Fed has raised its target for the Federal-funds rate charged on overnight loans between banks from 1% to 4.5%, but long-term Treasury yields have remained between 3.75% and 4.75%. Long-term rates are now barely above short-term rates, creating a flat "yield curve," which in the past has often presaged a slowdown or recession. For the first time since Mr. Bernanke became chairman, the Fed's policy-making committee meets Monday and Tuesday. It is expected to raise the funds rate by one-quarter percentage point to 4.75%. It also is likely to signal a bias to raise rates further, though possibly with less certainty that it has to date. Although Mr. Bernanke steered away from any clear signal on the direction of interest rates, his speech was notable in that he gave more weight to factors favoring a lower "neutral" funds rate than have some other current and previous Fed officials. Most officials who have studied the issue agree a variety of factors are at work; what differs is their emphasis. Former Fed Chairman Alan Greenspan had previously suggested low long-term rates mainly reflected increased -- and perhaps, unwarranted -- confidence by investors that future economic growth, market conditions and inflation will be predictable and stable. New York Federal Reserve Bank president Timothy Geithner in a recent speech argued an important factor holding long-term rates down was foreign central banks' purchases of U.S. bonds. Mr. Bernanke, though, gave little weight to the impact of foreign central bank buying. That should have only a "short-term" impact, he said, noting that "long-term yields continued to fall over recent quarters" even as foreign central bank buying of Treasurys slowed. Mr. Bernanke, like other officials, argued the yield curve did not seem to be foreshadowing a slowdown, noting it has usually required higher short-term rates than are in place at present for that to occur. He also reviewed several structural factors that could be holding down long-term rates. Economic growth and inflation have become less volatile, so investors may not demand as much of a cushion for unexpected moves in interest rates in the future. He noted the economy was also less volatile in the 1950s and 1960s and the structure of interest rates was similar. He said pension funds may demand more long-term bonds to fund the benefits of future retirees, while at the same time issuance of very-long-term U.S. dollar bonds has diminished. If these factors explain why long-term rates are so low, "the effect is financially stimulative and argues for" a higher Fed funds rate, "all else being equal."