Tags: bond | vigilantes | fed

Bond Vigilantes Thwart Fed Easing Plan

Tuesday, 09 Jun 2009 11:28 AM

By Dan Weil

The Federal Reserve has run into a dilemma.

It has eased monetary policy massively in order to pull down interest rates and spark economic recovery.

But that very easing has pushed long-term rates up sharply as the so-called “bond vigilante” investors sell of their bonds out of fear that coming inflation will destroy their returns in short order.

The 10-year Treasury yield hit a six-month high of 3.90 percent Friday after news of slowing job losses in May.

And the rate for 30-year fixed mortgages surged to 5.45 percent last week from 4.85 percent in April, according to Bankrate.com data.

“The Fed is stuck in a very difficult place,” Mark MacQueen, a partner at money management firm Sage Advisory Services, tells Bloomberg.

“You can’t have it both ways. You can’t say I’m going to stimulate my way out of this problem with trillions of dollars in borrowing [on one hand] and keep rates low by buying through the other.”

“I don’t think that is perceived by anyone as sound policy.”

Bloomberg calls this situation the “Bernanke conundrum.” That’s a takeoff on the “Greenspan conundrum” of 2005.

In February of that year, then Fed Chairman Alan Greenspan told Congress that falling long-term bond yields in the face of multiple interest rate cuts by the Fed represented a “conundrum.”

Now the current Fed chairman, Ben Bernanke, has one of his own.

Some experts say the Fed will have to reverse its stimulus soon.

"We are going to have to start raising rates or you'll have hyperinflation," Howard Simons, market strategist at Bianco Research, tells Reuters.

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