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Greenspan Says Low Bond Yields Remain Unsolved Puzzle (Update4) Listen
June 7 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan said the ``unusual'' decline in long-term U.S. Treasury yields still can't be fully explained and that a situation in which short- term yields exceed long-term returns may not signal an economic slowdown, as it has in the past.
Historically, an inverted yield curve -- a period when short- term rates surpassed long-term rates -- was ``a forward indicator for softening economic activity,'' Greenspan said in response to a question after speaking, via satellite, to the International Monetary Conference today in Beijing.
``I cannot tell you whether in fact we will see an inverted yield curve,'' Greenspan said. ``We would not automatically assume that it would mean what it meant in the past.''
Greenspan's comments suggest he still views falling market yields on government debt as an anomaly. The central banker said much the same thing when he told Congress on Feb. 16 that declining long-term rates, even as the Fed raised short-term rates, was a ``conundrum.''
Explanations such as a glut of global savings, which may spur bond buying, can't fully explain why yields are falling in the U.S. and worldwide, the central banker said. Other possible causes such as increased bond demand from pension funds because of an aging population also don't answer the questions, he said.
``I think the flow of funds is altered in such a dramatic way since the last time we saw that sort of inverted yield curve that I'd be doubtful to merely extrapolate'' from the pre-1980s period, Greenspan said. ``I do know we would have to look closely at why it is happening.'' Falling Yields
Yields have been falling partly because of global investors buying U.S. debt, Greenspan said. Asked whether there would be any change soon, he said: ``I would think not.''
The benchmark 10-year Treasury note due in May 2015 rose 5/16 point, lowering the yield to 3.91 percent at 9:04 a.m. in New York from 3.95 percent yesterday, according to Cantor Fitzgerald LP. The yield was at 4.58 percent on June 30, 2004, when the Fed began the current cycle of short-term rate increases. The Fed lifted the benchmark rate to 3 percent on May 3, the eighth consecutive increase.
``The pronounced decline in U.S. Treasury long-term interest rates over the past year, despite a 200-basis-point increase in our federal funds rate, is clearly without precedent,'' Greenspan said. Hedge funds seeking high returns eventually may find fewer options and the industry ``could temporarily shrink,'' he said.
Greenspan's words carry extra weight in a week with few economic releases, traders said. The 79-year-old Fed chairman, whose non-renewable term as a governor expires in January, is scheduled to testify about the economy before the Joint Economic Committee on June 9.
Greenspan to Testify
``That's the main event of the week,'' said Timothy Mulholland, executive director at Melamed & Associates, a Chicago- based futures consulting firm, in an interview.
John Herrmann, director of economic commentary for Cantor Fitzgerald LP in New York, agreed that it's likely the lower rates don't signal a slowdown. ``Lower interest rates are there for a host of reasons'' and help the economy by stimulating the real estate market,'' he said in an interview.
Central bank purchases of U.S. government securities also have had only a ``modest'' effect on long-term yields and can't fully explain the ``unusual'' behavior of these rates, Greenspan said. What's more, bond yields are falling ``virtually everywhere,'' including in emerging market economies whose currencies typically aren't held as reserves by other central banks.
Hedge Funds May Shrink
A ``globalization process,'' or the removal of national barriers to the production of goods and services and the flow of capital and labor, is probably behind many of the forces pushing yields lower, Greenspan said. What's more, so-called home bias, or a preference for investors to invest in their own markets, appears to be declining, he added.
Investors are turning to hedge funds, lightly regulated pools of capital open to wealthy investors, for higher returns, the Fed chairman said. There is a risk that strategy will become less effective with time and that the hedge fund industry may contract.
``After its very rapid advance, the hedge fund industry could temporarily shrink, and many wealthy fund managers and investors could become less wealthy,'' the Fed chairman said. Such an adjustment, though it has risks, ``should not pose a threat to financial stability.''
Greenspan said that in a search for rising returns, ``hedge fund managers are devising increasingly more complex trading strategies.'' While some of these approaches exploit temporary market inefficiencies, others may fail, he said.
`Low-Hanging Fruit'
``Most of the low-hanging fruit of readily available profits has already been picked,'' Greenspan said. ``Significant numbers of trading strategies are already destined to prove disappointing.''
Greenspan said that models used to price and hedge collateralized debt obligations, or pools of bonds and other debt instruments, ``are just beginning to be tested.''
Hedge funds added $24.6 billion in the first quarter, according to a report last month by Tremont Capital Management Inc., following inflows of $123 billion last year. Hedge fund assets total more than $1 trillion.
Greenspan said hedge funds help financial markets because they increase the ease of trading and spread financial risk. There are likely to be problems in complex financial instruments, although markets can ``readily absorb those mistakes,'' he added.
Answering a question about low U.S. savings, Greenspan said the U.S. is using the scant savings it has very ``efficiently,'' with high gains in productivity.
