Thursday, August 04, 2005

WSJ article extract: (Fed Sees Bond Market Hampering Its Steps to Keep Inflation in Check)

Many factors influence bond yields: expected inflation, which erodes an investor's purchasing power; the world-wide supply and demand for credit; what economists call a "term premium," the extra yield that investors demand for the many risks of lending money over a longer term, including fluctuations in economic growth and inflation; and Fed actions.

Last month, Mr. Greenspan told Congress that a declining term premium is the main reason bond yields have stayed low for the last year, not economic weakness. Those low rates, he said, are the main fuel for the buoyant housing market. The U.S. Treasury is also expected to exploit the cheap borrowing costs by reintroducing the 30-year bond today.

In a recent speech, Fed Governor Donald Kohn suggested some decline in the term premium is appropriate, because economic growth, inflation and Fed policy appear to have become more predictable.

But Mr. Greenspan last month strongly suggested that he thought investors may be complacent. "Risk takers have been encouraged by a perceived increase in economic stability to reach out to more distant time horizons," he said. "Long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress."

His comments are eerily similar to ones he made in 1999 about lofty stock prices. "An unwarranted, perhaps euphoric, extension of recent developments can drive equity prices to levels that are unsupportable...[which] could create problems for our economy when the inevitable adjustment occurs," he said in July 1999.

No comments: