Global bond selldown may reduce expectations for faster rate hikes

Bernanke, Trichet Get Inflation Help From Surging Bond Yields
By John Fraher and Scott Lanman

June 15 (Bloomberg) -- The six-week global bond market-rout may be doing Ben S. Bernanke and Jean-Claude Trichet a favor.
The higher market rates, if they continue, mean pricier loans for homes and credit cards, and will make it more expensive for companies to invest and make acquisitions.

That in turn may limit the need for Federal Reserve Chairman Bernanke and European Central Bank President Trichet to raise interest rates to cool inflation pressures amid the strongest global economy in a generation.

``It's certainly helping do their job for them,'' said Keith Hembre, who used to work at the Fed and is now chief economist at Minneapolis-based U.S. Bancorp's FAF Advisors Inc., which manages $105 billion. ``It's really, in essence, the equivalent of an additional Fed tightening.''

Hembre estimates that a 30 basis-point rise in the yield on 10-year Treasury notes may be equal to increasing the Fed's benchmark rate by 1 percentage point to 6.25 percent, according to a computer model used by the central bank's staff.

``When we're seeing this backup in rates even without the Fed moving, it's sort of a tightening in and of itself,'' said Kevin Flanagan, a fixed-income strategist at Morgan Stanley in New York.

After years of failing to move in tandem with rates set by central banks, U.S. and European yields have surged to their highest levels since 2002. The yield on the U.S. 10-year note has climbed 52 basis points in the past month and rose to 5.32 percent on June 13, the highest since April 2002.

German Yields
The yield on Germany's 10-year bond, a benchmark for Europe, has risen 34 basis points in the same period and climbed to 4.7 percent two days ago.

Mickey Levy, New York-based chief economist at Bank of America Corp., disputes the idea that higher bond yields may reduce the need for central-bank action. While the housing slump may worsen, there's ``absolutely'' no way to quantify the link between yields and the Fed's benchmark rate, he said.

``It shouldn't have that big of an impact,'' Levy said. In major industrialized countries such as the U.S. and Germany, ``real bond yields have been well below their longer-term average'' and are now moving toward that average. ``It's just an adjustment,'' he said.
Bernanke, 53, and predecessor Alan Greenspan raised the Fed's target rate on overnight loans between banks 17 times, from 1 percent in June 2004 to 5.25 percent a year ago.

Greenspan's `Conundrum'
During that period, the 10-year Treasury yield fell to 4.18 percent from 4.58 percent. The failure of long-term rates to increase prompted Greenspan to tell Congress in February 2005 that ``the broadly unanticipated behavior of world bond markets remains a conundrum.''
After two years of raising their benchmark rate, Fed officials decided in August to stop, partly to wait for the previous increases to have their intended effect. At the same time, officials retained a stance that inflation is the principal economic risk facing the U.S. economy.

``Their general feeling is at 5 1/4 percent, the fed funds rate is probably slightly restrictive,'' said Peter Hooper, chief economist at Deutsche Bank Securities Inc. in New York. ``Other financial conditions have been quite accommodative, and now we're seeing some unwinding of that.''

Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, said he recently lowered his forecast for the housing market to reflect more-expensive mortgages. He maintains that the Fed will raise its target rate on overnight bank loans next year, reaching 6 percent by mid-2008.

Stronger Growth
``Part of what's happening is growth is stronger, and higher rates are reflecting it,'' Kasman said.

In the euro region, where the ECB has raised its rate by 2 percentage points since December 2005, the move in bond yields might persuade Trichet, 64, to curtail his tightening, according to Robert Barrie of Credit Suisse Group.

While some economists expect the ECB to raise its main rate to 5 percent by next year from the current 4 percent, tighter financial conditions might allow it to stop before then.

``The market's making the ECB's job easier,'' said Barrie, the bank's chief European economist in London, who expects the central bank's rate to peak at 4.5 percent. ``The risks to the forecast were on the upside, but are now to the downside because of what the markets are doing.''

Judging the impact of higher yields on monetary policy may depend on what caused the move in the first place, said Jonathan Loynes, chief U.K. economist at Capital Economics Ltd.

Asian Central Banks
A decline in demand from Asian central banks for U.S. Treasuries may make it easier for the Fed to influence long-term bond yields because it will lessen the downward pressure that emerging-market purchases exerted in recent years.

On the other hand, if the increase was caused by investor expectations for central-bank rate increases, policy makers may have to follow through.

``I don't expect the move in yields to have a large impact on policy,'' said Loynes, who is based in London. ``The relations are too complex, and they can't necessarily count on these moves being sustained.''