WASHINGTON (Reuters) - Federal Reserve Chairman Alan Greenspan said on Wednesday he was just as puzzled as everyone else about why long-term interest rates have remained low in spite of official rate increases by the central bank.
"For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum," Greenspan told the Senate Banking Committee.
The admission by Greenspan that there were no easy explanation for why long-term interest rates are so low surprised observers, and analysts said the comments suggested the bond traders may be mispricing the market.
"There is some hint that perhaps the bond market has got it wrong and yields shouldn't be this low. It is certainly bearish for the bond market," said Alan Ruskin, research director at 4CAST Ltd in New York.
The 30-year bond price suffered, dropping a full point with the yield rising to 4.55 percent from 4.49 percent Tuesday. Five-year notes slipped 7/32 to yield 3.76 percent.
The Fed chief outlined several possible explanations for the dip in forward real interest rates since June.
"The favorable inflation performance across a broad range of countries resulting from enlarged global goods, services and financial capacity has doubtless contributed to expectations of lower inflation in the years ahead and lower inflation risk premiums," he said.
"But none of this is new, and hence it is difficult to attribute the long-term interest rate declines of the last nine months to glacially increasing globalization," Greenspan said.
He said the view that investors were guessing that oil prices would hold back growth did not appear to "mesh seamlessly" with rising stock prices and narrowing credit spreads.
SHORT-TERM ABERRATION?
Greenspan said other analysts pointed to an increased demand for credit by U.S. businesses and the willingness of lenders to provide financing -- notably foreign central banks, who have bought U.S. Treasuries irrespective of market fundamentals.
Greenspan also said mortgage investors might be buying longer-term securities to offset shorter duration among mortgage-backed securities, possibly contributing to downward pressure on long yields.
He warned U.S. policy-makers should be careful in attributing the interest rate declines solely to technical factors in the United States, because there has been a similar worldwide narrowing in yields and risk spreads.
"Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience," Greenspan said.
Regardless of the reason, bonds have tended to rally more often than not, and despite widespread predictions for significant spikes in yield, and Greenspan may have been trying to reverse the trend with his words of caution.
"Historically, when the Fed tightens, the curve flattens, but long rates do go up as well, and this is not the pattern that has been followed," said Stephen Stanley, chief economist at RBS Greenwich Capital Markets.
"It has got to be something they are concerned about. They don't want to have a disturbance some time in the future if we get back to the usual pattern. They would rather it happen slowly and steadily, rather than all at once," Stanley said.
Part of the resilience in the long-end has been due to popular curve-flattening trades, bets that longer-dated securities would perform better than their shorter-dated counterparts as official interest rates climb.
The spread between 10- and two-year notes narrowed dramatically in recent months, and at its current level of 76 basis points, was still within reach of a 3-1/2-year low touched last week. (Additional reporting by Pedro Nicolaci da Costa in New York)
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