NEW YORK -- Former Federal Reserve Chairman Alan Greenspan's bond market "conundrum" is unraveling as global yields rise amid signs of faster economic growth and central banks' staunch anti-inflation stand.
Also pushing up longer-dated bond yields are moves by central banks, most notably China, to diversify from sovereign bonds into riskier assets such as stocks and corporate bonds.
"That would be a contributing factor in the conundrum to be unwinding," said Ray Stone, managing director at Stone & McCarthy Research Associates, in Princeton, New Jersey.
"For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum," Greenspan told Congress in February 2005.
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Greenspan used the term to describe the stubbornly low long-term bond yields against rising short-term rates at a time when the Fed was in the midst of a policy-tightening campaign that saw 17 rate increases over the two years ended in late June 2006.
In fact, U.S. long yields were so low that they had ranged below short-term rates for much of the past 12 months even after the Fed stopped raising rates. This yield curve inversion has often been a harbinger of an economic recession in the United States.
But so far a U.S. recession has not materialized, despite a housing slowdown, and data have suggested that growth in other parts of the world is accelerating.
Long-term yields have reacted accordingly, catching up with short-term rates since June. Meanwhile, short-term rates have continued to rise, as central banks are responding to growing inflationary pressures.
The Bank of Canada raised interest rates by a quarter-percentage point to 4.50 percent, nearly a week after the Bank of England hiked rates. The European Central Bank and the Bank of Japan have both signaled they are ready to lift rates.
When Greenspan used conundrum more than two years ago, the federal funds rate, the short-term borrowing cost that the Fed targets, was at 2.50 percent and the benchmark 10-year Treasury note yield was a touch above 4 percent.
The fed funds rate currently stands at 5.25 percent where it has remained for a year while the 10-year Treasury yield touched a five-year high above 5.30 percent in June.
Yields in other countries have also risen; for example British gilt yields are not far from nine-year highs.
To be sure, the conundrum has not disappeared given the relative flatness of the yield curves, or the relatively small spread between short- and long-dated yields.
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Greenspan, his Fed successor Ben Bernanke and economists have attributed this conundrum to a decline in inflationary expectations, excess overseas manufacturing capacity and a global savings glut.
"That liquidity has gone into risky assets," said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey. "The need to own long Treasuries doesn't exist right now."
Japan and China have traditionally been the two largest foreign holders of U.S. government securities, stemming from their huge trade surpluses with the United States. Since the beginning of the year, however, Japan has pared its Treasury holdings while China has slowed its purchases.
Japan and China combined own more than $1 trillion of Treasury securities, equivalent to a quarter of total U.S. government debt outstanding.
Scaled-back buying by Japan and China has been partly blamed for a sharp rise in longer U.S. yields in June.
"Further driving the sell-off is the suspicion that the market is unwinding Greenspan's conundrum, with Asia backing away from U.S. Treasuries," said Wan-Chong Kung, senior portfolio manager at FAF Advisors in Minneapolis.
More importantly, global yields will head higher on inflation pressure as a consequence of the robust growth in China and India, she said.
"Yet another theme that's holding sway over markets is the notion that China and India, which had been credited with holding down global inflation, are increasingly turning into net exporters of inflation as they experience exponential growth and cost increases," Kung added.
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