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Fed chief bombs bonds
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July 22, 1999: 3:32 p.m. ET
Greenspan speech derails Treasury market, leaving dollar to twist lower
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NEW YORK (CNNfn) - Federal Reserve Chairman Alan Greenspan knocked the wind out of the bond market Thursday by reawakening dormant fears that U.S. interest rates could go back on the rise in the near future.
Greenspan adopted an unexpectedly wary tone in his semi-annual Humphrey-Hawkins testimony to Congress on the state of the U.S. economy. Of particular relevance to bond traders, the Fed chief said he remains vigilant for signs that inflation could be readying a full-fledged comeback, and that he will not hesitate to act "forcefully and promptly" to combat inflation by raising interest rates.
The rate-sensitive bond market plunged immediately after digesting the comments, remaining sharply weaker all day. Shortly before 3 p.m. ET, the benchmark 30-year Treasury bond had lost 3/4 of a point in price to 90-5/32, pushing the yield back up to 5.95 percent.
Even more tellingly, Greenspan chilled investors' hopes that the Fed had ruled out rate hikes in the future after the Federal Open Market Committee (FOMC) voted last month to raise interest rates only slightly, but also abandoned its tightening bias.
"By its June meeting the FOMC was of the view that the full extent of [last year's rate cuts] was no longer needed," he said. "It also did not believe that its recent modest tightening would put the risks of inflation going forward completely into balance."
According to Greenspan, the bias shift was as much a matter of public relations as actual Fed policy change because a neutral stance allowed the FOMC a wider field of action, while keeping financial markets from banking on the outcome of future rate votes.
"Given the many uncertainties surrounding developments on both the supply and demand side of the economy, the FOMC did not want to foster the impression that it was committed in short order to tighten further," he said.
Even though inflation remains minimal in the expansive U.S. economy, the FOMC has taken a preemptive stand in combating what it sees as the certainty of rising prices in the near future. The rate panel voted last month to raise the key Fed funds rate by a quarter of a percentage point and left the possibility of successive rate hikes open.
Rising interest rates counteract inflation by curbing economic growth, a process that incidentally saps the strength of both stocks and bonds by making them less competitive investments compared with cash or savings accounts.
Morning exuberance fades
The bond market's downturn came after a morning spent mostly in the sun, the beneficiary of nervous safe-haven buying from overseas. A sharp decline in the Japanese stock market overnight encouraged risk-averse investors to park their money in the safety of Treasury bonds, although the flight failed to encourage much broader buying before the rate fears reemerged.
Likewise, a lackluster jobless claims report had only minimal effect on the bond market even before Greenspan started talking, and traders had long since forgotten the release as the day drew near a close.
The dollar got little boost from the sign that higher interest rates may still lurk on the horizon, even though rising rates normally benefit the U.S. currency by making it more expensive to deal in greenbacks.
In late U.S. trading, the dollar had tumbled more than 1-1/2 yen to 116.64, having touched a six-month low of 116.17 shortly after the voice of Greenspan made itself felt.
Traders said the day's retreat from both U.S. stock and bond markets robbed the greenback of support by curbing overseas investors' demand for dollars. Bullish dollar-denominated securities channel international money into dollar markets, while market downturns have the opposite effect as overseas traders cash out of Wall Street or the Treasury market and repatriate their funds.
As in previous weeks, the Bank of Japan remained a looming presence in yen markets, leaving traders unwilling to commit themselves to long-term positions as long as Japanese monetary authorities actively resist the yen rising against the dollar or other global currencies.
However, the dollar's dramatic losses this week -- the greenback has fallen about 4 yen in value since Friday -- emboldened speculators, who now believe that if the BOJ still wanted to support the U.S. currency, it would be doing so more aggressively.
Euro trading took a back seat as the dollar fell, leaving the European unit nearly flat at $1.0522. 
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