Fed Not Worried on Rate Inversion

Federal Reserve Chairman Alan Greenspan didn’t get any closer Tuesday to solving his “conundrum” -- why long-term interest rates have declined even as the Fed has tightened credit -- but he indicated that the central bank wouldn’t be worried even if long-term rates fell below short-term rates.

In a question session after a speech he gave by satellite to a conference in Beijing, Greenspan was asked whether it would be a bad sign for the economy if long-term rates, such as 10-year Treasury note yields, dropped below shorter-term rates, such as two-year T-note yields.

Historically, when long-term rates have been less than shorter-term rates -- a so-called inversion of the normal rate, or yield, curve -- it has been a sign that investors expected the economy to weaken, Greenspan said.

“I cannot tell you whether in fact we will see an inverted yield curve,” the Fed chief said. But he added, “We would not automatically assume that it would mean what it meant in the past.”

The 10-year T-note yield was at 3.90% on Tuesday, just 0.34-point more than the 3.56% yield on the two-year T-note.

A year ago, the difference, or spread, between those yields was 2.07 points, when the 10-year T-note was at 4.77% and the two-year note was at 2.70%.

Greenspan repeated that the Fed was unsure why long-term yields had fallen so sharply over the last year -- a phenomenon he called “a conundrum” in February. But he listed a number of possible reasons, including the speed with which money moves among nations as investors seek attractive returns.

A “globalization process,” or the removal of national barriers to the production of goods and the flow of capital and labor, is probably behind many of the forces pushing long-term yields lower, Greenspan said.

“I think the flow of funds is altered in such a dramatic way since the last time we saw that sort of inverted yield curve that I’d be doubtful to merely extrapolate” from previous experiences, Greenspan said. It is a “credible notion” that such a shift in rates could mean a weaker economy ahead, but “we would have to look closely at why it is happening,” he said.

In the past, inverted yield curves have occurred when investors have rushed to lock in yields on longer-term securities, betting that the economy would slow and that the Fed would soon be reducing short-term rates significantly.

But this time, many analysts believe the Fed will continue to raise its key short-term rate, now 3%, through the end of this year, regardless of what happens with long-term bond yields.

JPMorgan Chase & Co. currency strategist Kenneth Landon wrote in a note to clients Tuesday that Greenspan’s comments suggested the Fed might keep lifting short-term rates even if the result was an inverted yield curve.

“I think they’re going to continue to move at the measured pace,” said Wesley Beal, chief U.S. economist at IDEAglobal.com in New York, referring to the Fed’s policy since June 2004 of raising its key rate a quarter point at each meeting of policymakers.

The Fed’s next meeting is June 29 and 30.