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Long-term bond yields jump as Fed chief pushes for higher inflation

October 15, 2010 | 11:33 am

Federal Reserve Chairman Ben S. Bernanke says the central bank wants to boost inflation.
The Treasury bond market seems to think he’s serious.

Longer-term Treasury yields jumped Friday after Bernanke made clear that the Fed is leaning heavily toward new steps to bolster the economy -- and to make sure that low inflation doesn’t turn into dreaded deflation.

In a speech in Boston, the Fed chief made the case for ramping up purchases of Treasury debt to try to flood the financial system with more money and push longer-term interest rates lower (i.e., “quantitative easing,” or QE).

Bensoct Bernanke didn’t say that a new QE program was a certainty, but he and other Fed officials have publicly discussed the idea so much in the last two months that Wall Street figures it’s a done deal.

Why, then, has the yield on the benchmark 10-year Treasury note risen to a three-week high of 2.58% on Friday from 2.49% on Thursday?

For one thing, the bond market has been anticipating QE by driving yields lower since early August, so  investors and traders figure some or much of the effect already is built-in.

But in stressing that the Fed believes that inflation has fallen too low, and that policymakers want to push it higher, Bernanke is reminding bond investors how they could be hurt in the long run -- because inflation eats away at fixed-rate returns on bonds.

Not surprisingly, the reaction to Bernanke’s inflation commentary is most severe in the longest-term bond, the 30-year Treasury issue. That yield has surged to 4.01% Friday, up from 3.90% on Thursday and the highest since mid-August. It had bottomed at 3.51% on Aug. 26.

Inflation obviously is very low, as the September consumer price index report on Friday showed. The Fed wants a higher inflation rate, though it doesn't say how high. If 1% inflation isn't acceptable, maybe 2% would make the Fed happy. Or maybe 3%.

In any case, by pouring more money into the financial system via bond purchases the central bank might just get what it wants.

But wait -- what about the goal of driving interest rates down further? The Fed might still accomplish that in the shorter end of the interest-rate spectrum. Even as 10-year and 30-year T-bond yields rose Friday, the yield on three-year T-notes slipped to 0.59% from 0.61% on Thursday. The five-year T-note was little changed, at 1.19%.

And even if the Fed won’t say so at the moment, it would probably regard higher long-term Treasury yields as a victory -- a sign that financial markets believe that deflation fears are disappearing, implying that the economy isn’t in danger of falling into an abyss.

-- Tom Petruno

Photo: Fed Chairman Ben S. Bernanke. Credit: Adam Hunger / Reuters