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In today's Motley Fool Take:

The Fed's New Stance

The easiest 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 the 10-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.

Quote of Note

"Everything I am or ever hope to be, I owe to my angel mother." -- Abraham Lincoln (1809-1865)

Citigroup Ups Its Dividend

Financial services giant Citigroup(NYSE: C) will raise its quarterly dividend (payable Aug. 22) to $0.35 from $0.20 -- a whopping 75%. Using yesterday's $47.12 close and assuming the dividend sticks, Citigroup would yield 3% annually, versus 1.7% before the change. The new 15% dividend tax rate puts more of this in investors' pockets, too.

The company said in a prepared statement that, in response to the new tax law, it would now pay in dividends capital formerly returned to shareholders through share buybacks. And return they do:

        Div'ds  Shares             
       Paid  Repurch'd  Total  
2002 $3,676  $5,483    $9,159   
2001  3,185   3,045     6,230
2000  2,654   4,066     6,720
1999  1,973   3,906     5,879 
1998  1,846   3,085     4,931
1997  1,692   3,447     5,139
In $millions

Dividends are the better deal for shareholders where a company like Citigroup appears to buy back shares regularly and without regard to whether they represent a good investment at current prices. At the same time, Citigroup deserves at least some credit: The tax change calls the bluff of those that buy back shares primarily to offset dilution and to cover up their high stock option grants. If they don't offer dividends, their fig leaf is gone.

Citigroup joins a growing list of companies, including Bank of America(NYSE: BAC), Microsoft(Nasdaq: MSFT), and Fannie Mae(NYSE: FNM), that have declared or upped their dividends in light of the tax changes. Citigroup's annual reports are mind-numbing, and those off-balance sheet special purpose entities (SPEs) make us feel like Charles Munger when asked why Berkshire Hathaway(NYSE: BRK.A) sold its Freddie Mac(NYSE: FRE) shares. His reply? "We just got a little nervous."

If you own Citigroup and have been rewarded -- as have many investors -- more power to you. But whether holding on or considering buying, make sure you understand Citigroup's complex financial operations. If you don't, resist the dividend bribe.

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Fannie Mae's Q2 Tanks

Fannie Mae (NYSE: FNM) reported reduced second-quarter earnings this morning, thanks to declines in its derivatives portfolio. The quasi-governmental mortgage-financing firm earned $1.09 a diluted share, compared to $1.44 in the same quarter last year. Net income fell 25% to $1.1 billion from $1.46 billion.

Both Fannie Mae and its smaller, embattled cousin Freddie Mac(NYSE: FRE) use extensive hedging techniques to offset the interest rate risk inherent in their businesses. However, this time around Fannie's unrealized losses worked against company.

Fannie Mae's mark-to-market derivatives portfolio booked $1.88 billion in losses for the quarter. That's substantially more than the $498 million in market losses during the prior second quarter. The company's net interest income actually rose 38%, though, to $3.5 billion. Excluding the derivatives' impact, Fannie Mae earned $1.86 a share, 20% ahead of last year's Q2 results.

Fannie Mae has worked hard to distance itself from Freddie Mac's accounting concerns. CEO Franklin Raines said recently in a BusinessWeek interview, "... We spent millions of dollars on internal systems and we maintain strict control over what kind of derivatives can be used and our accounting for them. We are compulsive about managing risk."

That's far and away from Freddie Mac's admission that "lack of sufficient accounting expertise and internal control" helped create the mess it's in. Still -- and unfortunately for shareholders -- the distinction between Fannie and Freddie may not be enough to sway headline-lovin' lawmakers from tightening regulatory controls over both companies as if they were one and the same.

Discussion Board of the Day: McDonald's

Have you checked out the latest line of electronic toy premiums at McDonald's? Isn't that auto racing game the coolest? Is the company really turning itself around or is this just a temporary blip after so many months of same-store-sales declines? All this and more -- in the McDonald's discussion board. Only on

Quick Takes

Investment bank and brokerage firm Merrill Lynch(NYSE: MER) announced a 61% catapult in Q2 EPS, driven by bond trading profits. Cutting expenses helped beget the fattest operating margin in 25 years, according to Bloomberg. Shares are up over 40% for the year.

Media company The New York Times(NYSE: NYT) reported Q2 EPS off 8% against a year ago. The company said that advertising revenues rose 3.4% and circulation sales 4.4%, but expenses grew a larger 6.6% due largely to a 6.3% hike in the price of newsprint. Meanwhile, advertising revenues grew faster than expenses at rival media giant and USA Today publisher Gannett(NYSE: G), leading to a 6.7% gain in its Q2 EPS.

The Bush administration said the budget deficit will be $455 billion this year and $475 billion next year, both 50% higher than its February estimates and far different from last July's forecast of a return to surplus in 2005. New spokesman Scott McClellan said the deficit would amount to 4.2% of gross domestic product and that the government should hold the line at 4%.

And Finally...

Today on

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Bob Bobala, Robert Brokamp, Paul Elliott, Mathew Emmert, Jeff Fischer, Tom Jacobs, LouAnn Lofton, Bill Mann, Selena Maranjian, Rex Moore, Rick Munarriz, Matt Richey, Reggie Santiago, Kate Southerland, Dayana Yochim