Bernanke sparks a bond sell-off with new inflation warning

Tuesday is setting up to be a lousy day for investors who own bonds.

Federal Reserve Chairman Ben S. Bernanke triggered a jump in government bond yields in Asia early Tuesday morning by declaring in a speech that "the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

Despite what Wall Street on Friday viewed as a troubling jump in the U.S. unemployment rate in May (from 5% to 5.5%), Bernanke, speaking in Massachusetts on Monday evening, said that "recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly."

What’s more, he repeated a warning he made on June 3 about the risk of rising inflation pressures -- a not-so-veiled hint that the Fed’s next step with interest rates was more likely to be an increase than a cut.

The Fed "will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation," Bernanke said Monday.

In Japanese trading early Tuesday the yield on the two-year U.S. Treasury note rocketed to 2.93% from 2.71% at the end of U.S. trading Monday. As market yields jump, remember, the value of older bonds drops.

Government bond yields have been on the rise in the U.S., Europe and Japan since mid-March as investors have become less fearful about a global economic slowdown -- and more fearful of inflation, given soaring energy prices.

In terms of acknowledging inflation risks, the Fed is behind the curve compared with the European Central Bank. ECB President Jean-Claude Trichet warned again on Monday that the ECB might raise its benchmark short-term interest rate (now 4%) as soon as next month to combat inflation.

Some Europeans may think he’s bluffing, but bond investors on the Continent evidently don’t: The annualized yield on the two-year German government bond jumped to 4.69% on Monday, up from 4.64% on Friday and the highest since -- believe it or not -- December 2000.

Michael Darda, economist at investment firm MKM Partners, noted earlier Monday that interest-rate futures markets have in recent days boosted their bet on when and how quickly the Fed would begin to raise its benchmark rate, now 2%.

The chance of a 0.25-point rise in the Fed’s rate in October was 88% on Monday, up from 48% on Friday, Darda said.

Bond investors now have to figure out what’s a fair yield to accept if the Fed really is leaning toward tightening credit.

Comments

[P.B.]

"the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

What planet does this guy live on? The Fed is so worthless. They are like a 4th branch of government but without any accountability or checks & balances.

[buz]

Time to raise rates before inflation realy gets out of hand and eats the economy alive. Damn the idiot housing flippers/ option ARM/ HELOC / neg amortization fools and wall street "geniuses" who concocted the whole mortgage "securitization" fiasco.

[John]

The fed is in the business of taking from the poor and giving to the rich, otherwise cost of living adjustments would include Food and Fuel when
computing Social Security and other Pensions. Does anyone know why Food and Fuel is not included in computing Cost of Living?

[Michael Snyder]

John,
"Core inflation" is a bit of "Greenspeak" invented to appease the Wall St. crowd who seemed to "overreact" to reality. The "justification" was the volatility of food & fuel prices and their negative impact on the stock market. This is just another example of the disconnect between Wall St. (where reality is adjusted to provide returns) and Main St. (where reality simply is).
Real inflation (with food & fuel included) has been running close to double digits for years and has neatly broken that barrier in the past few months. Although mundane, a can of hash has gone from $2.29 to $3.49 since January. Most investors on this blog would be thrilled with that kind of return, but the sad reality is just more people going to bed hungry.
Mark my words; it is the people on the margins that suffer first in times like these and those folks make up over a quarter of the local population. The recent uptick in violence is just the tip of an iceberg drifting for Los Angeles. Summer in the city sucks for those with no means of escape. Add in rising unemployment and a heat wave and what we'll have is about a million hungry, frustrated, bored people just waiting for an excuse to go off.

[Juanito]

It's a long time - from now to October.

[martscan]

Mike Snyder:

I trust you took my advice and put on 10 or 20 sugar spreads. For a neophyte, I suggest you take profits on the number of contracts that afford the return of the initial required margin, i.e., 10 X $280 = $2,800. That may leave you with, say, 5 contracts and no risk (provided you use stops that are not blown through). This spread WILL continue to work and you should now pyramid with profits, i.e., add 4, 3, 2, 1 for a total of 15 open trades. Let's further surmise that you liquidate the trade with an average of, say, 125 points on each of the 15, that's $21,000 plus the $2,800 on the first 5 for a total of $23,800..less commissions of $150 +/- for a net gain of, call it $23,500, or 840% in perhaps 10 trading days. Ergo, efficaciousness of leverage. You'd be less than human if you didn't wish you had started with a 100.....then 98....96....94......and mah kong! A new Bentley.