Little Concern About Inverted Curve

"The Fed acted early to avoid an over-acceleration of the economy, and it's worked," says Jerry Webman, director of fixed income at OppenheimerFunds. Webman doesn't see the yield curve steepening until the Fed changes course and starts cutting rates. "And they won't do that until the economy runs into trouble -- which we don't expect for a while."

Considering the growth of the economy, Webman's rosy outlook looks well founded. The Commerce Department said last week that gross domestic product rose 4.3% from July through September, up from its "advance" reading of 3.8%. GDP grew by 3.3% in the second quarter and 3.8% in the first quarter.

... While Foreign Buyers Hold Down the Long End

While the Fed was exerting all its energies pushing up short-term rates, the long end of the yield curve never seemed to get the memo that it was time to move on up. In what came to be known as "Greenspan's conundrum," long-term rates remained at record lows, keeping the yield curve flat and the Maestro perplexed.

Fund managers, and surely by now the Fed's august members, have long since realized that foreign buyers -- referred to as indirect bidders at Treasury auctions -- have been suppressing yields on the long end and will continue to do so as long as the U.S. needs to plug its massive budget deficit.

And for their part, foreign Treasury bond buyers, especially in Asia, have no qualms plowing money back into U.S. bonds -- even at rock-bottom yields -- to keep the U.S. financial system afloat, and their own export-oriented economies humming.

"This time it's different because the long end is being propped up by technical, not fundamental reasons, basically foreign buying," says Jim Hopkins, fixed-income strategist for all of State Street Global Advisors' mutual funds. "Foreign governments are regulating companies to match assets and long-term liabilities, which means they are shopping for bonds way out on the curve."

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