Bond Yields Retreat on Calming Words From Greenspan on Rates
Has the bond market’s latest interest-rate conniption run its course?
Market yields tumbled on Thursday, extending their slide from last week’s 19-month highs, after Federal Reserve Board Chairman Alan Greenspan hinted that short-term rates are going up--but probably not dramatically.
The 10-year Treasury note yield--a benchmark for mortgage rates--dropped to 5.79% on Thursday from 5.93% on Wednesday and the peak of 6.04% last Friday.
The yield on the bellwether 30-year Treasury bond fell to 5.96% Thursday from 6.06% on Wednesday and 6.16% last Friday.
Bond yields have been rising since early April on the assumption that the Fed, worried about the U.S. economy’s strong pace, would sooner than later boost its key short-term interest rate--thus signaling its desire for higher rates in general to cool the economy.
While the Fed’s key rate, the federal funds rate (an overnight loan rate among banks) has remained at 4.75% since last fall, the market as usual has tried to anticipate the Fed. Hence, bond yields have surged as investors have placed their bets on how much of a rate increase the Fed would ultimately engineer.
Greenspan’s testimony to Congress on Thursday apparently convinced many bond investors that the central bank will at worst raise the federal funds rate one-quarter point at the June 29-30 policy meeting, and no more than another quarter-point sometime this summer.
That would leave the fed funds rate at 5.25%--still below where it was late last summer.
Greenspan’s testimony indicated that the Fed “has no intention of [using] brute force” with rates, said Paul McCulley, executive vice president at bond-fund giant Pacific Investment Management in Newport Beach.
“Now the issue is one or two increases,” he said.
That belief is not universal. A minority of economists, including Lou Crandall of R.H. Wrightson in New York, believes the Fed won’t make any change in rates at the upcoming meeting.
But with the majority view that some increase is coming, the issue for Wall Street is whether yields on longer-term bonds have already priced in the worst-case scenario.
If that’s the case, market yields could decline further, dragging down other rates--such as those for mortgages--with them.
The average rate on 30-year fixed-rate mortgages hit 7.65% this week, the highest level in two years. If Treasury bond yields just stay at current levels, mortgage rates are expected to pull back somewhat in coming weeks.
But the question of how much further bond yields might fall, if at all, remains the subject of much debate in the market.
Many economists watch the yield on two-year Treasury notes relative to the fed funds rate. If the fed funds rate is boosted to 5% at the Fed’s next meeting, the yield on two-year notes--about 5.5% now, down from 5.69% last Friday--could fall a bit more, Crandall said.
But if the market in coming weeks assumes that the Fed will raise the fed funds rate to 5.25% before it’s finished, then the current yield on two-year notes is about fair, McCulley said.
Still, experts warn that the bond market, like the Fed, will remain a hostage of future economic data: If the numbers suggest that U.S. growth is accelerating--and that inflationary pressures are indeed building--then yields could take off again, anticipating that Greenspan’s now-moderate approach will turn more hawkish.
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Fed Effect
Worries about the Fed’s interest rate plans have sent the yield on the 10-year Treasury note soaring, but those fears have ebbed substantially this week. Weekly closes and latest:
Thursday: 5.79%
Fed’s key short-term rate: 4.75%
Source: Bloomberg News
