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Federal Reserve Chairman Ben S. Bernanke didn’t call it a recession today, but he might as well have.
In his semiannual congressional testimony on the economy, the Fed chief delivered a sober assessment that left no doubt about the central bank’s priorities.
Remember his tone in June, hinting that the Fed might soon raise interest rates to battle inflation pressures? Forget that -- despite another scary inflation report today.
 Bernanke’s speech "strongly suggests that Fed officials do not have their fingers on the tightening trigger," Goldman Sachs economists said in a note.
The Fed chief said policymakers felt that "considerable uncertainty surrounded their outlook for economic growth and viewed the risks to their forecasts as skewed to the downside."
Asked whether he thought the country was officially in recession, he said: "People are very worried, so I certainly would never make the claim that even if we were not in a technical recession, that it wasn’t a serious situation."
The stock market took this hard at first, with the Dow Jones industrial average diving 227 points early on. But the market has since rebounded, helped by a drop in oil prices that also appears to be driven by Bernanke’s recession-like tone.
Near-term crude futures in New York were down $6.71 to $138.47 a barrel at about 11 a.m. PDT. The Dow was basically flat at 11,060.
But Bernanke’s comments brutalized the dollar. The euro spiked to a record high of $1.604 today from $1.592 on Monday.
Photo: Ben Bernanke before the Senate Banking Committee today. Joshua Roberts/Bloomberg News
The stock market looks like it dodged a couple of bullets today, but the modest rebound in the Dow Jones industrial average during the half-day session couldn’t salvage the week.
And take a guess which commodity closed at yet another record high.
The Dow added 73.03 points, or 0.6%, to 11,288.54, but lost 0.5% for the holiday-shortened week and stayed in bear-market territory, off 20.3% from its October peak.
 The broader market was much worse, for the day and the week. Investors continued to unload some of the stocks that held up best for them in the second quarter, particularly smaller issues. The Russell 2,000 small-stock index lost 1% today and 4.6% for the week, and is down 22.2% from its all-time high reached nearly a year ago.
The slow-motion crash in bank stocks also continued, suggesting no easing of the latest jitters over the financial system. On the new-lows list today yet again: Bank of America, Wachovia, Comerica, U.S. Bancorp and Zions Bancorp, among others.
The government’s report of a net loss of 62,000 jobs in the economy in June nearly matched expectations, so that was a relief to some on Wall Street.
Should it have been? The debate over whether we are, or aren’t, actually in a recession will go on, but to some analysts there’s no question anymore.
Merrill Lynch & Co.’s econo-bear, David Rosenberg, says the lesson from history is that "you don't have six consecutive monthly declines in payrolls and not be in an outright recession."
For stock investors, the issue is what the slowdown/recession/whatever will mean for corporate earnings. Analysts have a dismal view of results for the quarter just ended: Operating earnings of the S&P 500 companies are expected to be down 12.4% from a year earlier, according to Wall Street estimates tracked by Thomson Reuters.
Yet those same analysts still believe the second half will bring a big turnaround. They’re expecting a 12.7% year-over-year gain in S&P earnings in the third quarter. . . .
Read on »
Thursday is looking like a big mess for financial markets. And since everybody's bracing for trouble, maybe we won't get it, and investors can limp off to their July 4th barbecues without much additional damage to their portfolios or their psyches.
Maybe.
In any case, it'll be a short day for Wall Street ahead of the Friday holiday: Stock markets will close three hours early, at 10 a.m. PDT, because who needs an extended holiday weekend more than the New York Stock Exchange's overworked mainframe computer?
Here's what on tap today:
--Pared payrolls: The government will release its June employment report at 5:30 a.m. PDT. The consensus expectation is that the economy lost a net 60,000 jobs last month, according to Bloomberg's regular survey of about 80 economists. That would make it a sixth straight month of job losses.
A much bigger number could fan the belief that a recession is underway, which would hardly be a confidence-builder for the stock market, fresh into an official bear market Wednesday on the Dow index and the Nasdaq.
 What's scary is that, if we're about to fall into recession, we aren't even close to the level of payroll cuts in previous downturns. The economy lost an average of 65,000 jobs a month from January through May. That was just about one-third the 181,000-a-month average of the last recession (March-November 2001).
--Euro rate hike: Jean-Claude Trichet, head of the European Central Bank, has been threatening for months to raise interest rates to fight inflation -- because, hey, that's what central bankers are supposed to do, oui? At their meeting today ECB policymakers are almost certain to make good on that threat, lifting their key rate from 4% to 4.25%.
Not a big deal? Tell that to the dollar, which is nearing a new low against the euro. The European currency jumped to $1.589 on Wednesday from $1.579 on Tuesday. Its record high was $1.599 on April 22.
The Federal Reserve's key rate is 2%. Higher rates in Europe give the continent an edge in attracting capital. That underpins the euro.
And what happens as the buck weakens? Commodity exporters, who price their stuff in dollars worldwide, earn less. We just hand them another reason to keep prices of raw materials, including (especially?) oil, on the rise.
So let's get out there and enjoy the weekend, before the next $10-a-barrel jump in crude.
Photo: A wag of my finger to you, Monsieur Bernanke! Jean-Claude Trichet. Pier Paolo Cito/Associated Press
A few notes from around the markets today:
-- As Federal Reserve meeting days go, this one was fairly uneventful for markets. Blue-chip stocks finished modestly higher and Treasury bond yields were mixed after the Fed, as expected, kept its key short-term rate at 2%. It was the first Fed meeting without a change in rates since August.
The central bank suggested in its post-meeting statement that the economy wasn't in such bad shape after all. "Although downside risks to growth remain, they appear to have diminished somewhat," the Fed said -- obviously discounting the abysmal consumer confidence survey results reported Tuesday.
-- "Inflation has been slightly higher than expected and there are prospects that inflation will move up further," the central banker said. "We give weight to preventing the higher rate of inflation from becoming entrenched."
 The Fed's Ben S. Bernanke? No, that was the Norwegian central bank's deputy governor, Jan F. Qvigstad, in a statement today after the Norges Bank raised its benchmark interest rate to 5.75% from 5.5%.
Bernanke & Co. continue to talk a good game about inflation concerns, but other central banks are taking action by tightening credit, the usual step to show you're serious about damping price pressures. Norway's rate hike followed similar moves recently by China, Mexico, Turkey, Brazil, India and South Africa.
Who cares what other central banks do? The dollar does. It slid today against many other currencies after the Fed's statement. (There go your hopes for that Oslo pub-crawl tour.)
It was just a few weeks ago that Bernanke strongly signaled the need for a rebound in the dollar to combat rising prices of imports, including oil. Yet there was no mention of the greenback in today's Fed statement, notes Joe Battipaglia, chief investment officer at brokerage Stifel, Nicolaus & Co. in Florham Park, N.J.
Never mind, Dr. Bernanke?
-- The Fed's relatively upbeat take on the economy must not have been persuasive to investors in financial-company shares, which have been battered by expectations of mounting loan losses. The BKX index of 24 major bank stocks jumped as high as 65.44 early in the session, a 4.9% leap from Tuesday's finish. But the index gave almost all of that back by the closing bell, ending at 62.62, up just 0.4% for the day.
That's still above the 10-year closing low of 60.87 reached Monday. But as Jay Shartsis, head of options trading at RF Lafferty & Co. in New York, reminds: "Every time the financial stocks look like they can't possibly go any lower, they go lower."
The BKX is down 29% year to date, compared with a 10% drop in the Standard & Poor's 500 index.
Like a hypnotherapist, the Federal Reserve keeps trying to talk us into an economic recovery.
"You will not need lower interest rates to feel better," Chairman Ben S. Bernanke tell us in so many words -- something he and his fellow Fedsters are likely to repeat again today as they gather and, almost certainly, hold their benchmark rate at the current 2%.
But the latest survey of consumer confidence shows that the Fed's relatively hopeful message isn't registering. Americans feel downright terrible about the economy as it is, and their expectations for the near future are even more depressed, according to the Conference Board's June consumer confidence report, issued Tuesday.
The overall confidence index, derived from questionnaires sent to 5,000 families, fell to 50.4 this month, down from 58.1 in May and the lowest since 1992.
 Worse, the expectations index in the survey -- how people figure things will look in six months -- dropped literally off the chart, to 41.0. That was the lowest figure in the 40 years of the survey, and broke through the previous low of 45.2 reached in December 1973 -- just as the economy was beginning to plunge into recession from the effects of the surge in oil prices that followed the Arab embargo announced that fall.
But something else in the latest survey really disturbed Lynn Franco, director of the Conference Board's consumer research center in New York, she tells me: The percentage of people who expect their income to drop in the next six months jumped to a record 15.9%. Even in December 1973, when consumers' overall expectations for the economy were dismal, only 10.8% expected their income to decline in the following six months.
Just 12.3% of consumers are expecting a rise in income over the next six months, compared with 19.4% a year ago.
It's true that consumer spending hasn't collapsed in recent months, thanks in large part to the federal tax rebate checks most families received. But once that money is gone, how do you have a consumer-led economic recovery in the second half with so many people feeling so bad about the big picture and about their personal financial situations?
Would lower interest rates help at this point? Maybe not. But in times of serious trouble it's always better for the Fed to have more bullets in the gun than fewer -- and right now, with its key rate at 2%, there aren't many bullets left.
What's more, with energy and food price inflation showing no signs of abating, Bernanke and other Fed officials have been talking in recent weeks about the need to begin raising interest rates as early as this fall to beat back price pressures.
Hike rates on consumers who are struggling to fill their gas tanks and have enough cash left over for groceries? It's true that quite a few other central banks around the world already have taken that unpopular policy route this year. But they're operating in economies that, for the most part, still are growing at a healthy pace.
The U.S. economy, by contrast, may not officially be in recession, but as Franco put it, never mind the terminology -- "to the consumer right now it feels like a recession."
Photo: And they thought they had it bad! President Nixon, right, listens to his energy policy advisor, John A. Love, in November 1973, one month after the Arab oil embargo was announced. Credit: John Duricka / Associated Press
The rich were on their way to getting richer today -- if they were buyers of long-term tax-free bonds in California’s $1.5-billion debt offering. The not-so-rich fared OK too.
The market for municipal bonds in general has turned rocky in recent weeks, favoring buyers over sellers and pushing interest rates higher. That forced the state to pay up to sell its longest-term issues in today’s offering.
The 30-year issue in the deal will pay interest at a 5.3% annualized rate, compared with 4.96% on 30-year bonds the state sold in early April. Because interest on the bonds is exempt from state and federal income tax, that 5.3% is equivalent to a much higher taxable yield (such as on a corporate bond or bank CD), depending on an investor’s tax bracket.
 For the already very well-heeled -- Californians with taxable income of $1 million or more, which puts them in the 41.7% combined federal and state income tax bracket -- a 5.3% tax-free yield is the same as earning 9.1% on a taxable investment.
Further down the income ladder, a married couple in the 32% combined tax bracket (taxable income of $89,629 to $131,450) would have to earn a taxable yield of 7.8% to equal a 5.3% tax-free yield.
The state also sold shorter-term bonds in the offering, as is usual in such deals. The five-year issue, for example, will pay 3.56% tax free, which in the 32% tax bracket is equivalent to a 5.23% taxable yield.
California Treasurer Bill Lockyer expects to use the bond proceeds to fund some of the state’s huge backlog of infrastructure projects and to pay off higher-cost debt.
How safe are the bonds? California has the second-lowest credit rating of all the states, and the budget situation is dismal. But debt repayment is mandated by the state Constitution. Check out this recent post I wrote on the safety issue.
As for the muni bond market overall, the latest upheaval is partly related to new credit downgrades last week of major bond insurance companies including Ambac Financial Group, MBIA and Financial Guaranty Insurance Co. That has left some investors unable to properly value certain bonds insured by those firms, said Matt Fabian, senior analyst at Municipal Market Advisors in Westport, Conn.
The result: Many investors have stepped back from the muni market, period, he said.
Given that backdrop, "California did fairly well with its offering," Fabian said.
Here are the tax-free yields on the California bonds sold today, by maturity:
Year Yield
2009 1.75%
2010 2.70%
2011 3.10%
2012 3.37%
2013 3.56%
2014 3.74%
2015 3.92%
2016 4.05%
2017 4.18%
2018 4.33%
2019 4.45%
2020 4.55%
2021 4.70%
2022 4.76%
2023 4.80%
2024 4.87%
2025 4.92%
2026 4.97%
2027 5.02%
2028 5.05%
2029 5.09%
2030 5.13%
2031 5.19%
2034 5.24%
2036 5.28%
2038 5.30%
California has had great luck selling tax-free municipal bonds to yield-hungry investors this year. The state is trying again today: It has $1.5 billion in general obligation bonds up for sale.
As a place to stash money away at a decent interest rate, it’s hard to argue against California’s bonds -– despite the state’s worsening economy and budget.
 Brokerages handling the sale for the state will be taking orders through 5 p.m. PDT today from small investors, and on Monday provided there are bonds left, according to Treasurer Bill Lockyer’s office. (The minimum order: $5,000.) Institutional investors will bid on Tuesday, and that’s when the final yields on the bonds will be set.
As usual, the securities are being offered in maturities of one to 30 years. Proceeds will be used to fund infrastructure projects and to pay off higher-cost debt.
The recent general rise in interest rates means the state will have to pay more on the bonds than it would have a few weeks ago -- good for investors, if not for taxpayers.
Expectations are for a tax-free annualized yield of about 4.33% on the 10-year bond issue, said Cameron Gloege, a bond trader at Wedbush Morgan Securities in L.A.
By contrast, the state paid 4.15% on 10-year bonds at its last big debt sale, in early April.
Here are ballpark yields for other bonds in the current offering: 2-year, 2.7%; 5-year, 3.56%; 20-year, 4.93%; and 30-year, 5.1%.
Because those yields are exempt from state and federal income taxes for California residents, they’re much better than they look, depending on your tax bracket. For a married couple in the 31% federal and state marginal tax bracket (that bracket begins at taxable income of $70,921), a 3.56% tax-free yield is equal to a fully taxable yield (such as on a bank CD) of 5.16%.
How safe are California bonds? Despite Sacramento’s latest budget mess, debt repayment is mandated by the state Constitution. See this recent post I wrote for more on the safety issue.
Note: The shorter-term bonds usually are very popular with small investors, which means they often quickly sell out.
A final reminder: You have to buy via a brokerage. The state doesn’t sell its securities directly to investors.
Photo: The Capitol in Sacramento. Credit: Robert Durell/Los Angeles Times
The Federal Reserve talks a lot about inflation.
The Bank of Mexico does something about it.
The Mexican central bank today surprised markets by raising its benchmark short-term interest rate to 7.75% from 7.5%, the first increase since October.
The bank said it tightened credit because "the recent inflation dynamic is worrying."
 Like most of the world, Mexico is battling rising cost pressures, particularly in food products.The country’s consumer price index rose 4.95% in the 12 months through May, well above the central bank’s target range of 2% to 4%, notes Nick Bennenbroek, head of currency strategy at Wells Fargo & Co.
Still, the bank’s move was unexpected because the government on Wednesday announced a deal with major food companies to freeze prices on more than 150 pantry items through the end of the year, in an attempt to ease the squeeze on consumers.
That was supposed to forestall an interest-rate hike. Instead, it looks like the Mexicans are taking the inflation battle seriously enough to risk slowing their economy with higher interest rates.
In the currency markets, at least, the Bank of Mexico’s decision is a hit. The peso has edged up to a five-year high against the dollar. The buck is worth 10.27 pesos this morning, down from 10.32 on Thursday and 10.36 a week ago. That’s not a big move, but it’s the trend that counts.
Interestingly, the Mexican stock market is suffering less today than the U.S. market. The Mexican IPC index was down about 0.6% at 10:45 a.m. PDT, compared with a 1.6% drop in the Dow industrials.
The U.S. inflation rate -- 4.2% for the year through May -- isn’t much lower than Mexico’s. But when Fed policymakers meet next Wednesday, they’re almost certain to leave their key rate at 2%, despite the recent barrage of rhetoric about being inflation-vigilant.
Given this week’s renewed carnage in bank and brokerage stocks on Wall Street, it’s clear the Fed is boxed in: Tighter credit could be a certain death sentence for many financial companies that are teetering on the edge.
Photo: Guillermo Perea/EPA
No more wondering why stocks are back in a funk: It’s because the people who invest the big money now have a truly dismal view of the equity market’s prospects.
That’s the takeaway from Merrill Lynch & Co.’s latest monthly survey of about 200 professional fund managers worldwide who control more than $700 billion in assets.
 The June survey, conducted the 6th through the 12th, indicates that the risk of stagflation -- rising inflation, rising interest rates and weak economic growth -- "is beginning to create a major headwind for equities," Merrill says.
Fund managers "have reacted to this unpalatable combination by reducing their exposure to equities and raising their cash positions."
Three numbers from the survey show just how dramatically investors’ perceptions have shifted:
-- The net percentage of managers who say they now are "underweight" in stocks (meaning they’ve cut back much more than normal in asset-allocation portfolios) jumped to 27% from just 5% in May. The June reading is the most bearish in a decade of survey results, Merrill says.
-- The net balance of managers who believe stocks to be "undervalued" plunged to just 1%. It had been 25% in the March survey. "This seems consistent with a world where growth is set to disappoint and where both long- and short-term interest rates are expected to rise on the back of inflation concerns," Merrill notes.
-- A net 81% of managers believe that analysts’ consensus corporate earnings estimates for the next 12 months are too high.
Is there a silver lining here? We all know that it’s often precisely when the crowd is at its most pessimistic about stocks that the market is likely to rally.
But that isn’t always true. Sometimes, the crowd is right, at least for a while -- if for no other reason than that investors, by engaging in group-think selling, can make a bear market a self-fulfilling prophecy.
Photo: Edvard Munch's Expressionist masterpiece "The Scream." Solum, Stian Lysberg/AFP/Getty Images
Central bankers have been busy over the last 24 hours trying to fine-tune markets’ expectations for interest rates.
The gist of their revised message: "We aren’t expecting to boost rates aggressively anytime soon." That is helping to pull government bond yields down modestly today after their recent surge.
Federal Reserve and European Central Bank officials have been talking tough on inflation for weeks, strongly hinting that they would tighten credit sooner than later to combat rising price pressures.
But they now appear to think that they put too much of a fear factor into financial markets, particularly in light of the fragile state of the U.S. economy.
The Wall Street Journal’s lead story today carries the headline, "Fed Mood Tilts Away from Rate Increase." It says the Fed could consider raising its benchmark short-term rate (now 2%) in August, but that policymakers would prefer to wait until fall.
Reuters has a good story here that wraps in the Fed’s attempt to calm markets and similar efforts on Tuesday by the ECB and the Bank of England.
The suddenly less hawkish tone on interest rates is bringing buyers into the Treasury bond market today. The two-year T-note yield fell to 2.92% by about 9:30 a.m. PDT, from 3.04% on Monday. The yield has jumped from 2.38% on June 6.
Not that the inflation news was cheery today: The Labor Department said its wholesale inflation gauge (the producer price index) soared 1.4% in May, the biggest rise since November, stoked as usual by surging food and energy costs.
The core inflation rate, excluding food and energy, was up 0.2% in May. While that looked tame enough, Bank of America Economist Peter Kretzmer notes that the 12-month change through May was 3% -- the highest core wholesale inflation rate since 1991.
Longer-term bond yields, which are highly sensitive to inflation expectations, remain sticky today. The 30-year T-bond yield is holding at about 4.78%, compared with 4.79% on Monday.
Maybe you can start dusting off those overseas vacation plans, after all: The beleaguered dollar suddenly is on a hot streak.
The greenback is rallying today against the euro, the yen, the Canadian dollar and other major currencies, lifting a closely watched index of the dollar’s value to its highest level since February.
The DXY dollar index, which measures the buck’s moves against six key currencies, was at 74.13 at about noon PDT, the highest since Feb. 27. The index has jumped 2.4% this week, a big move compared with its usual shifts.
 The euro has slumped to $1.535 today from $1.542 on Thursday. The European currency peaked at $1.599 in mid-April.
Just a week ago the dollar was hammered by the government’s report of a jump in the unemployment rate in May to 5.5% from 5%. Anything that dims faith in a country’s economy usually is bad news for its currency.
But this week, sentiment toward the buck has rebounded sharply -- although not necessarily for reasons that will make average Americans feel good.
One factor is the growing belief that the Federal Reserve will begin raising short-term interest rates this fall to combat inflation. The Fed has encouraged that idea with tough talk on inflation, including a throw-down-the-gauntlet speech on Monday by Chairman Ben S. Bernanke.
"There has been a pretty significant shift in expectations on rates," said Kathy Lien, currency strategist at DailyFX.com. Higher interest rates could attract more global investors to U.S. bonds, underpinning the dollar.
Today, although the "core" rate of inflation in the government’s May consumer prices report remained relatively tame, Treasury bond yields are mostly higher after dipping early in the session. That’s a sign investors continue to bet on a credit-tightening move by the Fed later this summer or early in fall.
The dollar also is getting a boost today from a blow to the euro’s image, after Irish voters rejected the European Union’s new governing treaty -- raising new doubts about prospects for greater political unity to tackle Europe’s problems. Bloomberg has a good story here.
The Irish vote "weakens the appetite foreign investors have for euro-denominated assets," said Michael Woolfolk, currency strategist at Bank of New York Mellon.
For the Bush administration and the Fed, almost anything that strengthens the dollar is welcome at this point, because a healthier buck could put downward pressure on prices of oil and other commodities, as I explain here. Crude oil today is trading lower, off $1.86 to $134.88 a barrel around noon PDT.
Photo: Michael Probst/Associated Press
Wall Street woke up this morning determined to have a nice day. But by the closing bell, the drugs had worn off.
You can thank the usual buzz killers: oil and the Federal Reserve.
The next test for rickety markets comes on Friday with the government’s report on May consumer price inflation.
Today, the Dow industrials were up as much as 186 points early on, nearly recouping Wednesday’s drop, after the government said retail sales rose 1% last month, the biggest jump since November. That was a clear sign that many consumers were spending their tax rebate checks, just as the Bush administration had hoped.
What’s more, a $46-billion takeover bid for Anheuser-Busch Cos. by Belgium’s InBev left the impression that foreigners, at least, may believe that U.S. stocks are cheap.
 And even oil cooperated, for a while, with near-term futures falling as much as $4.83 a barrel, to $131.55.
But there seems to be no way to keep the oil bulls down for long these days. The price rebounded by the end of trading, closing up 36 cents at $136.74 a barrel -- even in the face of a stronger dollar, which usually pulls commodity prices lower. As oil recovered stocks sank. The Dow closed at 12,141.58, up 57.81 points, or 0.5%; broader indexes were weaker.
Wall Street also was spooked by the latest Fed missile launched in the war of words on inflation. Charles Plosser, president of the Fed’s Philadelphia bank, said on CNBC that the central bank must "act preemptively" to damp inflation pressures. That added to the growing belief that the Fed will begin boosting short-term interest rates by fall. (And if the consumer keeps spending, that gives the Fed more cover to make a move.)
"It looks like they do want to start raising rates," said Ray Remy, head of fixed income at Daiwa Securities in New York.
Plosser’s comments helped spark another big sell-off in Treasury bonds that pushed the yield on the two-year T-note to 3.04%, the highest since Dec. 31. (How much have investors’ rate expectations changed in the last week? Just last Friday they were willing to buy two-year T-notes at a yield of 2.38%. D’oh!)
The Fed’s new inflation paranoia places more than the usual importance on the May consumer prices report due Friday. Most analysts figure prices were up 0.5%.
But Ian Shepherdson of High Frequency Economics warned in a report today that "the unpredictability of food, home heating oil and utility prices means a slightly bigger increase is also possible."
Get the drugs ready.
Photo: Charles Plosser. Federal Reserve Bank of Philadelphia
"It can’t get much worse," you figure if you still own a bank or brokerage stock.
To which the market responds: Try me.
Financial shares were bludgeoned again today, driving many to new multiyear lows and leading Wall Street’s retreat.
It’s hard to overstate how drastically investors’ views of these stocks have changed over the last two weeks. Consider: Sellers of Newport Beach-based mortgage lender Downey Financial were willing to take as little as $4.47 a share to get out of the stock today. Two weeks ago the price was 76% higher, at $7.85.
Bank of America, which was trading at $33.87 two weeks ago, has fallen nearly 15% since, to $28.85.
 This selling wave is an acceleration of a downturn that began for many financial issues early in May, following a bounce in the stocks in late March and in April.
What has changed in the last few weeks? Rumors about financial trouble at Lehman Bros. cropped up as June began, and there was more than a kernel of truth in them: Lehman on Monday said it would report a $2.8 billion loss in its latest fiscal quarter -- far exceeding analysts’ worse fears -- because of another round of write-downs on commercial-property mortgages and other investments.
The bigger industry issue this week has been deepening fear that the Federal Reserve, with its sudden focus on inflation risks, might begin to raise interest rates this fall.
One of the Fed’s main goals in slashing its benchmark short-term interest rate to the current 2% was to make sure loss-ridden financial firms could borrow cheaply as they try to repair their eroded balance sheets. If the Fed tightens credit, that repair job becomes a lot tougher, which means many financial companies will take longer to get back to health -- if they can get there at all.
And in the meantime, as Lehman showed, the bleeding from loans and investments gone bad hasn’t stopped.
In its report today on regional economic trends, the Fed included a specific warning about banking troubles in its Western region, including California. Since mid-April, the report said, credit quality at Western banks has "eroded a bit further, mainly for loans related to the housing sector, with the most significant adverse impacts on asset portfolios noted for smaller community banks."
That may help explain heavy selling this week in shares of small- and mid-size California lenders such as EastWest Bancorp, Cathay General Bancorp and FirstFed Financial.
The Federal Reserve hasn’t raised its benchmark short-term interest rate. But it might as well have, given how yields are rising on Treasury bonds.
And that is a distressing turn of events for mortgage rates and for the struggling housing market.
Yields on Treasuries have been in an upward trend since mid-March, but the trend gave way to a spike the last few days: The yield on the two-year T-note ended at 2.92% on Tuesday, up from 2.71% on Monday and 2.38% on Friday.
A move of a half-percentage-point in two trading sessions is nearly unheard-of.
 Bond yields rise, of course, when investors are bailing out, pushing bond prices lower. And there has definitely been a rush for the exits. "This is the get-me-out trade," said Tom Di Galoma, a veteran bond trader at brokerage Jefferies & Co. in New York.
Why the sudden urge to sell? The Fed seems to have gotten religion about inflation pressures in the economy, with oil’s surge above $130 a barrel. Chairman Ben S. Bernanke warned about the risks of higher inflation in two speeches over the last week.
The implicit message: Don’t expect the central bank to make another cut in its benchmark rate, now 2%. In fact, be prepared for a rate hike, particularly if oil doesn’t come down.
That is driving two camps of investors away from Treasury bonds. Camp One comprises "people who had been betting on a weakening economy," Di Galoma said. Bernanke, in his speech Monday, indicated the Fed was less worried about the economy than inflation.
Camp Two: Investors who figured the Fed was done cutting rates, but who believed a rate increase wouldn’t happen before 2009. Now, the concern is that Bernanke might want to start tightening credit in the fall.
David Ader, chief government bond strategist at RBS Greenwich Capital in Greenwich, Conn., said he still expects the Fed to wait until next year to raise its key rate. But with its new hard-line on inflation, Ader said, "The Fed is trying to tighten credit without actually tightening."
Many on Wall Street believe the Fed’s immediate goal is to bolster the dollar. As I explain here, that could help bring down commodity prices and thereby damp inflation.
Di Galoma is warning clients that Treasury yields may continue to rise as shell-shocked investors reassess the Fed’s stance. The two-year T-note yield, he said, could jump to 3.2% in the near term.
And although longer-term Treasury yields haven’t risen as quickly as shorter-term yields, the 10-year T-note, at 4.11% on Tuesday, was the highest since Dec. 27.
The housing market can’t like the sound of this. The mortgage market takes its cue from longer-term Treasuries, which could mean more upward pressure on mortgage rates. The average 30-year home loan rate was 6.09% as of last week, up from 5.98% two weeks earlier and the highest since mid-March, according to mortgage finance giant Freddie Mac.
The latest jump in bond yields "is not a welcome circumstance," said Keith Gumbinger, vice president at mortgage research firm HSH Associates. He was trying to be gentle.
If a potential home buyer is having trouble making the math work because of higher mortgage rates, guess what the home seller will probably have to do to his asking price?
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.
The U.S. dollar has a new BFF: Federal Reserve Chairman Ben S. Bernanke.
And that revelation may be helping to drive oil down to a three-week low today.
In a speech, the Fed chief took the unusual step of declaring the central bank’s interest in "ensuring that the dollar remains a strong and stable currency."
His comments are helping to push the dollar up, albeit modestly, against the euro, the yen and other key currencies.  And as the dollar appreciates, that’s negative for commodity prices, because it removes one incentive for higher prices of oil and other raw materials. They've risen in recent years partly because of the greenback's long slide: Most commodities are priced in dollars worldwide, so a weak buck means commodity producers -- and speculators -- have had more motivation to seek higher prices to offset the U.S. currency's devaluation.
Crude oil prices were down $3.06 to $124.70 a barrel at about 11:30 a.m. PDT, while the euro fell to $1.546, down from $1.555 on Monday and the lowest since May 15. (Not that any of this is helping the stock market today, which is broadly lower for a second day.)
Bernanke’s defense of the buck is unusual because currency issues normally are the U.S. Treasury’s concern, not the Fed’s. But the dollar’s decline is helping to stoke inflation in the U.S. by boosting prices of imported goods, and inflation is what the Fed is paid to worry about. (Never mind, for now, that a weak dollar is a boon to U.S. exporters.)
"The challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation," Bernanke said in a speech via satellite to a financial conference in Spain.
"We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations," he said.
Bernanke is "putting the market on notice that [the dollar] has begun to reach a level that may be uncomfortable" for the Fed, Goldman Sachs & Co. economists said in a note.
"Not since the days of the Louvre Accord more than 20 years ago has the Fed drawn an explicit line in the stand against the weakness of the dollar," said Michael Darda, economist at MKM Partners in Greenwich, Conn.
And what that also means, of course, is that the Fed is highly unlikely to cut interest rates further. Bernanke strongly hinted as much today: "For now, policy seems well-positioned to promote moderate growth and price stability over time," he said.
Photo: Fed Chairman Bernanke at a conference in May. Scott Olson/Getty Images
Investors who bought U.S. Treasury bonds in the last few weeks are having a bad case of buyer's remorse: Yields in that market keep rising and this week crossed some important thresholds.
The yield on the 10-year T-note, for example, has jumped above 4% for the first time since the beginning of January. It reached 4.08% on Thursday, up from 3.33% in late March. That's a big move for a 10-week span. Today the yield eased to 4.05%.
Wall Street, however, isn't quite sure how worried it should be about the turnabout in bond rates. Some part of the rebound is a welcome return to normalcy after the financial-system-meltdown scare of mid-March (the Bear Stearns debacle), when investors rushed into Treasuries for safety.
But there also is a gnawing fear among bond market pros that the Treasury market is playing the coal-mine canary role on inflation: meaning, investors are demanding higher fixed yields on Treasuries to compensate for their concern that inflation will contine to rise and ultimately force the Federal Reserve to begin tightening credit.
Given $130-a-barrel oil, "I think the notion of inflation taking root now is a global concern," said T.J. Marta, fixed-income strategist at RBC Capital Markets in New York.
Global indeed: Government bond yields in Europe and Japan also have shot up in recent weeks. The 10-year German government bond yield hit 4.43% on Thursday, the highest since last fall.
At the same time, though, yields on riskier bonds -- such as U.S. corporate junk issues -- have risen only modestly this month. The yield on an index of 100 junk issues tracked by KDP Investment Advisors was 9.30% on Thursday, up from 9.12% on May 1 and down from 10.16% in mid-March.
That suggests that some investors who have exited Treasuries have moved their money into riskier securities. That's exactly what the Fed has been hoping to see, as a sign of faith in the wobbly economy. Meanwhile, mortgage rates have edged up as Treasury yields have climbed, but at 6.08% this week the average 30-year home loan rate remains below its mid-March level of 6.13%, according to mortgage giant Freddie Mac.
With the Fed holding its benchmark short-term interest rate at 2% some bond market analysts say Treasury yields have backed up enough for now. "I think the market has hit levels where it's attracting buyers," said Brian Edmonds, head of interest rates at bond dealer Cantor Fi | |
