The surest way to interpret Alan Greenspan-speak is to watch the bond market. After today's 10 a.m. release of the Fed chairman's testimony before Congress, the 10-year Treasury yield started a sharp climb that didn't level off until yields were 17 basis points higher than when the day began.
Interpretation? The risk of deflation is much lower than previously thought.
Implication? Chances are good that interest rates have seen their lows of this cycle.
This bond market move is powerful. The benchmark yield began the day at 3.73%; by noon, it was 3.85%; and as of early afternoon, the yield had reached 3.90%. That puts the yield on the10-year Treasury at its highest since May 6 -- and an incredible 83 basis points higher than its June 16 low of 3.07%.
Today's bond-market action seemed a reaction to the last four paragraphs of Greenspan's testimony, which were on the subject of inflation. Basically, Greenspan concluded that our fledgling economic recovery, along with a continued low level of inflation, will be enough to offset any meaningful risk of deflation. The key excerpt is as follows:
A very low inflation rate increases the risk that an adverse shock to the economy would be more difficult to counter effectively. Indeed, there is an especially pernicious, albeit remote [emphasis mine], scenario in which inflation turns negative against a backdrop of weak aggregate demand, engendering a corrosive deflationary spiral. ... However, given the now highly stimulative stance of monetary and fiscal policy and well-anchored inflation expectations, the Committee concluded that economic fundamentals are such that situations requiring special policy actions are most unlikely to arise.
The bond market's subsequent sell-off (lower prices, higher yields) signaled a reversal of deflationary sentiment. Previous Fed comments had played up the possibility of deflation, along with the possibility of the Fed taking radical measures to fight it. In particular, within the past few months, the Fed has openly considered targeting lower long-term interest rates (whereas traditional Fed policy has only involved manipulation of short-term rates).
Now, however, those "special policy actions," as Greenspan referred to them in his testimony, are no longer under any serious consideration. As a result, bond traders no longer have much incentive to hold long-term Treasuries at multi-decade low yields. That's the substance of today's bond market sell-off.
Still, the question remains as to whether the economy really will pick up enough steam over the coming quarters to offset any renewed deflationary concerns. Stay tuned.