Updated from 10:50 a.m. ESTTreasuries fell and the yield curve inverted again Tuesday, as Federal Reserve Chairman
"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.