Fed must convince Wall St. on bank policy

Federal Reserve Chairman Ben S. Bernanke has to convince investors that the Fed can take back more than $1 trillion it pumped into the U.S. banking system to pull the economy out of the longest decline in more than six decades.

Bernanke and his colleagues, who meet Tuesday and Wednesday to map monetary strategy, have said they need to continue buying assets and keep interest rates low for a long time to help revive growth.

Rising Treasury bond yields show Wall Street is concerned that Fed officials’ policy may lead to an inflationary bubble: 10-year notes reached an eight-month high of 3.95% on June 10.

“The markets don’t understand the Fed’s exit strategy; they’re confused,” said Lyle Gramley, a senior economic advisor at Soleil Securities Corp. and former central bank governor. “That’s contributed to the rise in long-term rates.”

The risk is that higher rates will hold back the economic recovery by raising borrowing costs for homeowners and home buyers.

“It’s not good for the economy,” said Michael Feroli, a former Fed official who’s now an economist at JPMorgan Chase & Co. “It pushes back the housing rebound.”

The yield on the 10-year Treasury note ended trading Friday at 3.78%, up from 2.21% at the end of 2008.

The average 30-year mortgage rate rose to 5.59% earlier this month, the highest since November, before slipping to 5.38% in the week that ended Thursday, mortgage financing giant Freddie Mac said.

Mortgage applications fell 16% in the week that ended June 12 to the lowest in seven months, the Mortgage Bankers Assn. said, as a jump in rates discouraged refinancing.

Although investor optimism about the economy may be contributing to higher Treasury bond yields, there are still worries about the record $1.8-trillion federal budget deficit, along with concern about the Fed’s plans, Gramley said.