Updated from 10:50 a.m. EST
Treasuries fell and the yield curve inverted again Tuesday, as
Ben Bernanke's comments Monday night delivered no new revelations about the future course of monetary policy.
Uncertainty is likely to hang over the market Wednesday, with no economic reports on tap for tomorrow and no Fed speeches between now and the
Federal Open Market Committee
meeting that begins next Monday. Traders could stay cautious ahead of the week's housing market data, next week's two- and five-year note auctions and a never-ending stream of rate-hike chatter.
"The market took Bernanke's comments as modestly hawkish, not so much for what he said but because he didn't contribute to the recent thinking the Fed might stop at 4.75%," says David Ader, a bond strategist at RBS Greenwich Capital. "Beyond the cooling of Fed-pause fever, Bernanke provided a mixed market call. He said that unusually low long-term rates could force the Fed to keep short rates higher than normal, for example ... or lower than normal due to global savings being high."
Alan De Rose, a bond trader with CIBC World Markets, agreed, adding that Bernanke's speech left the market with the impression that there are more rate hikes ahead.
"I would say there are two more interest rate hikes," De Rose says. "Everything after that ... is data dependent."
Interest-rate futures show that traders are betting that the Fed will raise rates next week by 25 basis points to 4.75%. After Bernanke's speech, the odds that the overnight lending rate will hit 5% at the next meeting in May rose to 91% from 73% in the previous session.
The benchmark 10-year note ended the day down 14/32 to yield 4.71%, while the 30-year bond sank 19/32 to yield 4.74%. Bond prices and yields move in opposite directions.
Meanwhile, the two-year lost 5/32 to yield 4.73% and the five-year fell 11/32 to yield 4.69%. The two-year yield is back above the 10-year yield for the first time since March 7.
Readings on existing-home sales will be released Thursday, and new-home sales data will hit the market Friday. Wall Street expects existing sales to have dipped to an annual rate of 6.5 million in February, from 6.56 million in the previous month. Purchases of previously owned homes account for about 85% of the market.
New-home sales are expected to come in at a 1.21 million annual pace in February, down from 1.23 million in the previous month.
A housing slowdown is a foregone conclusion on Wall Street, with economists debating just how soft the market will become. The important question is whether it will mean a severe cutback in consumer spending, which accounts for about two-thirds of U.S. economic activity.
A mixed wholesale price report released early morning did little to clarify the economic growth picture. The headline number came in softer than expectations, keeping inflation fears in check. The February producer price index fell by 1.4%, vs. an expected 0.2% dip, down from January's 0.3% gain. But the core rate posted showed a stronger-than-expected gain, up 0.3% vs. estimates for a 0.1% gain.
Longer-dated maturities, i.e., the 10-year note and the 30-year bond, typically yield more than shorter-dated notes because it is riskier to loan money for longer periods of time. Moreover, inflation erodes the value of the dollar over time and thus the value of a Treasury note or bond; higher yields help compensate for that erosion.
When shorter-maturity yields have risen higher than longer-dated yields, this has historically preceded an economic recession. But Bernanke said that a recent spate of inversions that began in December do not mean that economic growth is slowing.
"I would not interpret the currently very flat yield curve as indicating a significant economic slowdown,'' the chairman told the Economic Club of New York Monday night.
Low yields on the long end of the curve reflect lowered inflation expectations, he said, arguing that shorter-term notes are still sensitive to fed funds interest rate expectations, whereas 10-year yields reflect the outlook for growth and inflation.
And since investors may be willing to accept less risk due to stable inflation, "the implications for future economic activity are positive rather than negative," Bernanke says.
San Francisco Fed President Janet Yellen last week touched off speculation that the Fed was growing dovish by saying that she would be "looking for signs of the delayed effects on output and inflation of our past policy actions and will be sensitive to the possibility that policy could overshoot."
She also said that despite limited slack in the jobs market and evidence that the economy is strong, "it's hard to find evidence suggesting upward inflationary pressures."
On Monday, Boston Fed President Cathy Minehan said that her short- and medium-term outlook for the economy is "quite positive" and that "overall, the economy in 2006 seems likely to be very well-behaved." But she also said that declining housing-market activity could have a greater impact than once assumed at the Fed.
The Fed has assumed that flattening home prices and dipping construction could lead to a modest dent in growth, with the central bank estimating 3.5% economic growth this year. "Clearly, however, we could be wrong on the magnitudes," Minehan said. "Real estate prices could actually decline."
But even though Bernanke's comments on the yield curve cooled heated speculation that the Fed is one more rate hike and done, Matthew Smith, vice president and fixed-income manager at Smith Affiliated Capital, says that the market has misinterpreted Bernanke.
"At the end of the day, it's different from what most people think is what happening. ... For Ben Bernanke, it's going to be 'expect the unexpected,'" says Smith.
Smith says that the market is focusing on lagging data and indicators that measure the health of the economy in the prior one to two months, when it should be paying attention to the fact that FOMC staff economists have lowered their forward-looking numbers.
He believes that it would make sense to lower growth expectations going forward because each of the upbeat economic reports released since the last FOMC meeting has been matched by a bearish report.