Posted on 06/07/2005 8:45:11 AM PDT by TigerLikesRooster
By MARTIN CRUTSINGER
WASHINGTON - Federal Reserve Chairman Alan Greenspan said Monday he does not have a good explanation for why long-term interest rates have been falling at a time when he and his Fed colleagues have been raising short-term rates.
Greenspan called the pronounced decline in long-term interest rates over the past year at the same time the Fed was boosting short-term rates "clearly without recent precedent."
Speaking by satellite to a monetary conference in China, Greenspan rejected the suggestion that U.S. rates have been held down by a massive flow of foreign investment from such countries as China. He said a recent Fed study found that foreign purchases of U.S. Treasury notes have had only a "modest" impact on U.S. interest rates.
Greenspan participated on a panel with key central bank officials from China, Japan and Europe.
He repeated comments he has made in the past that it would be good for China to stop pegging its currency, the yuan, tightly to the U.S. dollar, a practice critics say has undervalued the Chinese currency and given the country a tremendous trade advantage over U.S. companies.
Greenspan, however, said he doubted the change would have much impact on America's record $162 billion trade deficit with China. But he said the change would boost the Chinese economy by making it more flexible.
"In enhancing global growth, it is important that the structure of the Chinese economy be as flexible and integrated into the world economy as much as possible," Greenspan said.
Zhou Xiachuan, head of China's central bank, told the conference that China needed to do careful analysis of the impact such a change would have on China's economy and make sure its financial system is prepared.
Officials in the Bush administration have been increasing the pressure on China to make a move soon to a more flexible currency, saying they have already taken all the preparations necessary.
Greenspan's comments on the conflicting movement of interest rates were his most extensive remarks on the subject since he called the persistence of low long-term rates in the face of Fed credit tightening a "conundrum" in February.
The Fed has boosted a key short-term rate, the federal funds rate, a total of eight times since last June 30, moving it up in quarter-point increments from a 46-year low of 1 percent to its current level of 3 percent.
But over that same time period, Greenspan noted, the yield on Treasury's benchmark 10-year note has fallen from around 4.8 percent a year ago to around 4 percent currently. The yield on the 10-year Treasury note dipped again Monday to 3.95 percent.
Greenspan said the continued decline in long-term interest rates has not been a development just in the United States but in many other countries around the world.
"Long-term rates have moved lower virtually everywhere," Greenspan said, noting that in many major economies the declines have been more pronounced than in the United States.
He said access to credit has even improved for many developing nations, noting bond sale success stories in Mexico and Colombia.
Greenspan said a number of explanations have been advanced for what he called "this remarkable worldwide environment of low long-term interest rates." But in examining the various explanations, Greenspan said, none of them seemed satisfactory.
He noted that some economists had advanced the idea that the large accumulation of holdings of U.S. Treasuries by foreign governments such as China had "doubtless" helped to lower rates on long-term U.S. Treasury securities. But he said a Fed study estimated that this impact was still "modest" given the overall size of the U.S. Treasury market.
Another explanation _ that the decline in long-term rates is signaling economic weakness ahead _ could not explain why rates continued falling in areas of the world even when other indicators were signaling strength, the Fed chief said.
Greenspan said the need of pension funds for increased investments as baby boomers near retirement or the fact that global financial markets have become more closely linked were not adequate explanations either.
"The economic and financial world is changing in ways that we still do not fully comprehend," Greenspan concluded.
In his comments, Greenspan also included a warning to operators of large hedge funds, investment vehicles for wealthy individuals, saying that most of the "low hanging fruit of readily available profits has already been picked."
He said hedge fund managers who feel driven to continue pursuing above-average returns may encounter risks to their investments that will result in setbacks for the hedge fund industry.
"Consequently, after its recent very rapid advance, the hedge fund industry could temporarily shrink and many wealthy fund managers and investors could become less wealthy," Greenspan warned.
But he said that as long as banks and other lenders to hedge funds manage their own credit risks effectively, "this necessary adjustment should not pose a threat to financial stability."
A service of the Associated Press(AP)
Perhaps, it's time for someone a little more open-minded and flexible...
Long term (ten year note) trading in a range is signaling that we are in an era where buyers expect interest rates and inflation to be low and steady for some time in the future. They are also signaling that there is not connection between the overnight rates that Greenspan controls and the ten year time frame. If this interpretation is correct, loans for housing will also be steady for some time to come. Good news for the housing market, as people can hold on to their homes for a while even if they took those variable loans.
The MARKET still prevails, Alan.
Rates are converging and the yield curve is flattening.
Long term rates reflect the markets inflation expectations. Raising short term rates reduces the long term inflation risk (at the very least, it shows markets that the Fed is serious about fighting inflation).
Not so hard really.
The market for borrowed money is no longer state or national, but international with the advent of the Internet. Setting interest rates in Wash DC has little relation to what rates the financial markets in Asia, Europe, Latin America or the rest of the world are willing to loan their money. The big bankers in NYC wanted a global economy, now they have one. Interest rates will remain low despite the Fed.
I think he's referring to the divergence in rate movements (short - up, long - down) not a divergence in the spread.
It won't last. When the fear becomes endemic and the bubble bursts, bankers will have to start qualifying loan applicants again instead of dumping them onto Fannie Mae. Recent law has also removed bankruptcy as a haven.
We need to take money control away from the central planners in the Fed, and return it to conservative bankers.
BUMP
"Anybody cares to enlighten confused Greenspan about interest rates movement?"
Profit motive. Short term, lenders are offering higher rates to encourage new deposits. Long term, being uncoupled from any real sense of risk due to paper being sold to what is (rightly or wrongly) perceived as a quasi-governmental body with "guarantees" (LOL) against default, as it is, brokers are offering low rates to encourage the fees and points generated with each new loan.
This would explain the US. That this is international in scope... hmmm. Can't really say.
I believe that the meaning of this is "China grows richer" since he is implying that our demand for Chinese goods will probably not decline even if China makes the yuan stronger -- i.e., we end up sending even more dollars for the same increasing amount of goods to China.
He noted that some economists had advanced the idea that the large accumulation of holdings of U.S. Treasuries by foreign governments such as China had "doubtless" helped to lower rates on long-term U.S. Treasury securities. But he said a Fed study estimated that this impact was still "modest" given the overall size of the U.S. Treasury market.
I believe this is incorrect; I would be interested in the analysis because I fail to see how with so much held overseas ($1.9771 trillion) that it cannot have an impact. (Japan alone has around $700 billion, which by itself is an appreciable fraction of the outstanding public debt of $4.569 trillion.)
So, he will increase short term rates like crazy until long term rates suddenly snap several points into conformity with a textbook model.
6 factors compressing term premia for interest rates;
-demand by foreign central banks
-demand by pension funds
-Investors reaching for yield
-minimal inflation risks
-Excess global savings
-Greater transparency from the FED.
Pension funds need to extend their maturities to keep the duration mismatch btwn assets and liablities in line. There is also some legislation in the pipeline that could force and extension of maturities of Pension investments. Look at the UK for a very vivid example of what pension funds can do to the shape of a yield curve. This is part of the "preferred habitat" of pension funds and insurance companies.
Greater transparency means less unknown variables and entices investors to go to longer maturity investments.
Minimal inflation risk means returns on investments are discounted less.
Reaching for yield. We call them yield whores who must maintain a certain underlying return and are less constrained by the riskiness in longer term maturities.
Excess global savings- very interesting. The more Americans import the more money foreign individuals/cos. have to invest. Some of that perhaps just a couple of % goes back into US$ assets.
Lots more but I have to get back to work.
Overseas holding of US$ assets is less than 2% of world GDP, implying that we are nowhere near a limit on how much the world is willing to hold in terms of US$ assets.
The economic "recovery" has not reached the masses in the form of full time work at good pay.
Pension funds usually try to match the duration of whatever benchmark they are using for their individual bond portfolios. That can be surprisingly short. The match between assets and liabilities gets made up by the pension fund's exposure to equities which, theoretically, have infinite duration.
The answer is simple.
He is raising short term interest rates either too quickly or too much.
He needs to take a break before we have another financial "accident"
There is too much gearing in the system for this heavy-handedness with trillions in derivatives and counter-party risk.
Buy Gold - it is now rising in all currencies.
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