Bernanke's Talk Proves Costly

"Today's testimony showed the markets the Fed isn't going anywhere any time soon," says Drew Matus, senior economist at Lehman Brothers, who adds that the testimony also let investors know that recession fears are as overblown as rate-cut hopes.

The bond market took heed to the hawkish talk on inflation, as the longer-duration bonds sold off in the wake of Bernanke's testimony. The 30-year bond fell 15/32 to yield 4.83%, while the 10-year note slid 4/32 to yield 4.62%. The two-year note remained flat to yield 4.56%.

"The selloff in the long end and thus the steepening of the yield curve argues bond traders thought more of the inflation talk than the business spending worries," says Don Kowalchik, associate vice president, fixed income at A.G. Edwards. In a way, it's a show of faith in the Fed, he says.

Worries about business investment were revived Wednesday as the Census Bureau reported durable-goods orders rose 2.5% in February, less than the 3.5% increase expected, while January's decline was revised to 9.3% from 7.8% previously. Aircraft orders pushed February's number higher, but the report was weak elsewhere. Non-transportation orders fell 0.1% in February, well-below analysts' expectations for a 1.8% increase.

"The Fed's continued vigilance about inflation has given long-bond investors a reason to rethink their bet," Kowalchik says. "It gives them a reason to move away from the long maturities due to inflation risk." The steeper yield curve, in turn, becomes a more positive indicator about the economy, he adds.

But Bernanke was much less reassuring about the future of the economy than he has been in recent testimony. On Wednesday, he provided plenty of evidence to support the downside risks but little to support the more-upbeat alternatives or positives, says Tom Higgins, chief economist at Los Angeles money management firm Payden & Rygel.

The burden, even in Bernanke's words, seems to fall on the consumer and whether or not they'll, well, just keep consuming.

"Consumer spending appears solid, and business investment seems likely to post moderate gains," reads the testimony. But then Bernanke proceeded to run down a laundry list of risks to that statement. They are not insignificant.

Housing "could turn out to be more severe than we currently expect, perhaps exacerbated by problems in the subprime sector," he said in the testimony. "Moreover, we could yet see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far. The possibility that the recent weakness in business investment will persist is an additional downside risk."