WASHINGTON (Reuters) - Policy-makers at the U.S. Federal Reserve stepped up their anti-inflation rhetoric this week after a bond market sell-off delivered a sharp reminder that they ignore investors at their peril. Extreme bond market volatility reflects uncertainty over the inflationary impact of aggressive Fed action to defeat the severe U.S. recession, and could cool the central bank toward further efforts to lift growth by buying up U.S. Treasuries. Fed Chairman Ben Bernanke tried to placate concerns that the central bank will tolerate higher prices to ensure recovery, while a couple of regional Fed bank chiefs called for an exit strategy from so-called quantitative easing. "This is a day of reckoning that the Fed would have hoped (would come) a year or two from now," said Gregory Hess, an economics professor at Claremont McKenna College in Claremont, California. "They have done big things and now they face the consequences." The Fed has more than doubled its balance sheet to $2 trillion and has promised to purchase $1.75 trillion of mortgage-related debt and longer-term U.S. Treasuries in a bid to drive down private borrowing costs and battle recession.
WASHINGTON (Reuters) - Policy-makers at the U.S. Federal Reserve stepped up their anti-inflation rhetoric this week after a bond market sell-off delivered a sharp reminder that they ignore investors at their peril.
Extreme bond market volatility reflects uncertainty over the inflationary impact of aggressive Fed action to defeat the severe U.S. recession, and could cool the central bank toward further efforts to lift growth by buying up U.S. Treasuries.
Fed Chairman Ben Bernanke tried to placate concerns that the central bank will tolerate higher prices to ensure recovery, while a couple of regional Fed bank chiefs called for an exit strategy from so-called quantitative easing.
"This is a day of reckoning that the Fed would have hoped (would come) a year or two from now," said Gregory Hess, an economics professor at Claremont McKenna College in Claremont, California. "They have done big things and now they face the consequences."
The Fed has more than doubled its balance sheet to $2 trillion and has promised to purchase $1.75 trillion of mortgage-related debt and longer-term U.S. Treasuries in a bid to drive down private borrowing costs and battle recession.
Here is the way it was supposed to work: Uncle Sam would borrow and spend trillions of dollars to save the economy and the financial system, but interest rates would stay near rock-bottom and nobody would worry about the potential side effects of all that spending -- like, say, inflation or a devalued dollar. Things aren't proceeding quite according to plan. The investors who are supposed to buy all of that new Treasury debt are rebelling, driving interest rates up. That's exactly what the housing market doesn't need. The average 30-year mortgage rate rose to a six-month high of 5.29% this week from 4.91% the previous week, according to Freddie Mac. And that was before Friday's big jump in Treasury bond yields, which are the benchmarks for many other interest rates, including home loan rates and municipal bond yields. The 10-year Treasury note yield rocketed to 3.86%, up from 3.71% on Thursday and the highest since November. -Skip- But it's the trend that's important here, and the broader implications. Even as Federal Reserve Chairman Ben S. Bernanke was on Capitol Hill this week warning that the U.S. risks borrowing its way into yet another crisis, Treasury Secretary Timothy F. Geithner was in China trying to assure the largest foreign owner of Treasury bonds that its investment was safe. Yet with every tick higher in market yields, the value of China's $770 billion in Treasury holdings erodes.
Things aren't proceeding quite according to plan. The investors who are supposed to buy all of that new Treasury debt are rebelling, driving interest rates up. That's exactly what the housing market doesn't need. The average 30-year mortgage rate rose to a six-month high of 5.29% this week from 4.91% the previous week, according to Freddie Mac.
And that was before Friday's big jump in Treasury bond yields, which are the benchmarks for many other interest rates, including home loan rates and municipal bond yields. The 10-year Treasury note yield rocketed to 3.86%, up from 3.71% on Thursday and the highest since November.
-Skip-
But it's the trend that's important here, and the broader implications. Even as Federal Reserve Chairman Ben S. Bernanke was on Capitol Hill this week warning that the U.S. risks borrowing its way into yet another crisis, Treasury Secretary Timothy F. Geithner was in China trying to assure the largest foreign owner of Treasury bonds that its investment was safe. Yet with every tick higher in market yields, the value of China's $770 billion in Treasury holdings erodes.
