Bonds Have Heard This Before

Yields are little changed as the new Fed chairman is 'Greenspanesque.'
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Updated from 1:08 p.m. EST

Déjà vu swept the Treasury market Wednesday, and yields barely budged after

Federal Reserve

Chairman Ben Bernanke left little doubt about a rate hike at the next policy meeting and the possibility of a data-dependent move in the future.

In other words, it was just how Alan Greenspan left it before his last

Federal Open Market Committee

meeting in January.

During his testimony before the House Financial Services Committee, Bernanke didn't stray from the FOMC's

last policy statement, saying that the economy is strong, that inflation is being closely monitored and that further rate hikes seem likely in the near future and will depend on data.

The fed funds futures contract shows near certain odds that the fed funds rate will hit 4.75% at the March FOMC meeting, as well as 5.0% by the end of June.

"I don't think anyone is skeptical about the next 25 basis point move

to 4.50%, and as far as a hike in May goes, that's pretty much in play," says Bulent Baygun, head of U.S. fixed-income strategy at Barclays Capital.

Now "4.50% is the new 4.25%," says Baygun. And while upcoming key economic reports are in the pipeline, he acknowledges that there will be a lot of marking time until the FOMC's next meeting on March 28.

The benchmark 10-year note ended the day up 2/32 of a point to yield 4.60%. The 30-year bond added 8/32 to yield 4.57%, after gaining as much as 20/32 following Bernanke's remarks. Bond prices and yields move in opposite directions.

The five-year and two-year notes were both unchanged on the session to yield 4.60% and 4.69%, respectively. The yield spread between longer-dated maturities and the two-year remained inverted, though the spread narrowed a bit from the morning. (

Click here for more on the inverted curve.)

"The risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately -- in the absence of countervailing monetary policy action -- to further upward pressure on inflation," Bernanke said in what will be a semiannual report to Congress, formerly known as the Humphrey-Hawkins testimony.

"It almost sounded like Greenspan wrote the speech for him," says Drew Matus, senior U.S. economist specializing in fixed income at Lehman Brothers. "When he promised continuity, he delivered."

Bernanke specifically cited higher energy prices and high levels of resource utilization as possible inflationary culprits. He gave no guidance as to when the Fed's rate-raising campaign would end.

The event was his first public speech since becoming Fed chief, and he will go through more of the same Thursday when he testifies before the Senate Banking Committee. Since his prepared remarks will be a repeat, the market will closely watch the question and answer period.

"By virtue of not hinting at any change in Fed policy, he was able to calm the market," says Baygun, referring to the fact that Treasuries were little changed. He adds that the key difference between now and the end of the Greenspan era is that most economists believe this will be a strong quarter.

"We're coming to terms with the fact that this quarter we're looking at much more solid growth," Baygun says. "Our bias is toward higher rates."

Bernanke took on a Greenspan-like tone with regard to the yield curve, tying the "conundrum" of low long-term yields to demand from pension funds and foreign buying. Most importantly, during the question-and-answer session, ongoing at this time, Bernanke argued that the "inverted yield curve is not signaling a slowdown."

"Given the more stable macroeconomic climate in the U.S. and in the global economy since the mid-1980s, some decline in risk premiums is not surprising," he said in his prepared comments.

The Fed sees 2006 GDP growth at 3.5%, and believes that the core personal consumption expenditures rate should stay near 2%, Bernanke says. He sees unemployment at between 4.75% and 5.0%.

Bernanke reassured the market that he will keep inflation expectations low and that "price stability is essential for strong and stable growth of output and employment," which pushed longer-dated maturity yields lower.

The morning offered up a series of economic indicators, including bearish housing market news. The weekly Mortgage Bankers Association's applications index declined by 7.3% last week, with purchasing applications down 7.9% and refinancing off by 6.5%.

Additionally, the Home Builders index of housing market activity held at 57 in February -- tied with the December and January levels.

Bernanke said in his speech that the Fed is closely monitoring a slowdown in housing price appreciation and refinancing activity, a sector that Greenspan famously warned was getting "frothy" or overheated in some regional markets. A slowdown could directly affect consumer spending, which accounts for about two-thirds of the nation's economic activity.

"Some cooling of the housing market is to be expected and would not be inconsistent with continued solid growth of overall economic activity," Bernanke said. "Slower growth in home equity, in turn, might lead households to boost their saving and trim their spending relative to current income by more than is now anticipated."

During the Congressional grilling, Bernanke added that the Fed's current expectation is that the slowing will be gradual and will be consistent with strong economic growth, but that the central bank is monitoring this closely.

He also emphasized that "the possibility of significant further increases in energy prices represents an additional risk to the economy. Besides affecting inflation, such increases might also hurt consumer confidence, and thereby reduce spending on nonenergy goods and services."

Oil prices fell below $58 a barrel Wednesday after the Energy Information Administration said that crude inventories rose by 4.85 million barrels last week, about three times more than the market had expected.

In other economic reports, the Empire State Manufacturing Index for February edged higher to 20.3 vs. expectations for a decline to 18. A reading of zero marks flat growth. The employment and workweek components dipped, as prices paid rose and prices received fell.

Traders also shrugged off a report from the Treasury Department that international investors bought fewer Treasuries in December than expected, boosting net holdings by $56.6 billion compared with a forecasted $76.2 billion.

Finally, January industrial production unexpectedly fell, with factory output down 0.2% vs. expectations for a 0.2% gain. The capacity utilization rate was basically in line with estimates at 80.9%.