Greenspan's Cautious Remarks Punish Bond Market

Market players see the Fed chief's comments as balanced, but the market seizes on a hawkish phrase and dives.
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What the bond market is saying and what the bond market did today are two completely different things. The bond market is saying things like, "

Alan Greenspan's

speech was balanced." Meanwhile, it's tearing out its own hair.

The

Federal Reserve

chairman's

Humphrey-Hawkins

testimony forced a flurry of selling as soon as it was released on the Web, and the market never recovered. The testimony, while somewhat more cautious than the past with regard to the tight labor markets and value in the equity market, also seemed to indicate that the Fed would not take a preemptive stance on tightening rates.

"Recent experience does seem to suggest that the economy has become less inflation prone than in the past, so the chances of an inflationary breakout arguably are, at least for now, less than they would have been under similar conditions in earlier cycles," the chairman said.

The most telling reaction to those remarks came from the fed funds futures pits. The yield on the March contract hovered at 4.77% to 4.78% all day, indicating confidence that the Fed will stand pat at the next Fed meeting March 30, and that no intermeeting policy changes will be undertaken. However, the yield on the July contract widened to 4.87% from 4.82%. The June contract widened to 4.83% from 4.81%.

Meanwhile, the 30-year Treasury bond fell 31/32 to 97 16/32, as the yield rose to 5.42%. The two-year note traded above 5%, the first time that has happened since August 1998, and lately was yielding 5.004%. The bond futures contract closed today down 27/32 to 122 26/32.

"The market usually has a tough time in the first quarter, but you still have to remember that there's enough problems out there and inflation is well enough contained to take a stab at some of this stuff," said Mitch Stapley, head of fixed income at

Kent Funds

. "The market still has a hard time reconciling the fact that the economy can grow and not generate inflation as a result."

But the sentiment in the bond market right now is predominately bearish. There are very few retail sponsorships, as investors are dining on

Peter Luger

-sized corporate and agency steaks, such as

Fannie Mae's

$3 billion issue that priced this morning before Greenspan's testimony. And today's somewhat hawkish comments would have been considered a speed bump in January's or even December's bond market.

A Market in a Bad Mood

"I think his comments were pretty balanced but the market has been in a pretty bad mood," said Kim Rupert, senior economist at

Standard & Poor's MMS

. "The reality of the situation is that growth is still strong, and labor markets are tight, and the Fed continues to still be caught off-guard by the favorable inflation scenario. With that in mind, the only option is that the Fed moves to a tightening bias unless we see a slowdown in growth."

The comment that got the bond market going was Greenspan's assertion that the "Federal Reserve must continue to evaluate ... whether the full extent of the policy easings undertaken last fall to address the seizing-up of financial markets remains appropriate as those disturbances abate." In addition, his closing remarks were devoted to the tight labor markets, and the Fed chairman wondered how much longer that can continue without some time of wage pressures.

Business Week

, in recent issues, has put forth the notion that some Fed officials have misgivings over the third rate cut, and this statement seemed to confirm that thinking. The two factors crucial to the rate cuts were the overseas weakness, and the liquidity and credit crunch that resulted. As those factors subside, the Fed may end up tightening rates, according to

Moody's

senior economist John Lonski.

"The driving forces behind the rate cuts are no longer in affect," Lonski said. "Perhaps the Fed has to reconsider the rationale behind those rate cuts."

Not that anybody was paying attention, but the

consumer confidence

index reached an all-time high, according to the

Conference Board

. The index tallied 132.1 for February, an increase of 3.2 points from January's 128.9 figure.

The chairman will repeat his prepared remarks for the

House Banking Committee

tomorrow. Today's schedule was a lesson in how to avoid being questioned on Humphrey-Hawkins testimony. Greenspan also presented testimony on financial services reform. With the exceptions of Sens.

Chuck Schumer

(D, N.Y.) and

Jim Bunning

(R, Ky.), his opinions on the economy and stock market were barely questioned, as senators on the Banking Committee focused on his ideas on reform.