Dec. 28 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke is ending the year with considerably more credibility in the markets than he had at the start.

After early doubts about the Fed chief's commitment to fighting inflation and charges that he was too candid about policy, investors are now giving the 53-year-old Bernanke a vote of confidence. The yield on the benchmark 10-year Treasury note has fallen to 4.65 percent -- from 5.25 percent in June -- even though he stopped raising interest rates in August with inflation above his declared comfort level.

Traders are now so confident that Bernanke, who took office in February, will keep prices under control that they are counting on rate cuts next year. Such faith contrasts with the chairman's first few months, when he was criticized for foreshadowing the rate pause and condemned for telling a CNBC reporter that he had been misunderstood.

``The Bernanke Fed showed us that they're both committed to their inflation objective in the medium term'' and ``more flexible in how they're going to respond in a real-world environment,'' said Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York.

Bernanke's early ``missteps'' in public statements have become ``rather modest issues,'' Kasman said. ``He's been relatively conservative in the way he's communicated'' since then.

The chairman's prediction that inflation would gradually slow is coming true. The Fed's preferred price gauge rose 2.2 percent in the year through November, down from 2.5 percent in August. The core personal consumption expenditures price index was unchanged from the prior month.

Shrinking Spreads

One gauge of inflation expectations watched closely by Fed officials has dropped during the past six months: The difference between the yield on 10-year Treasuries and Treasury Inflation Protected Securities, or TIPS, was 2.26 percent yesterday, down from the year's high of 2.74 percent in May.

``If there were any concerns about the Fed having let the inflation genie out of the bottle, you cannot see it in the market,'' said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ in New York. ``I give the current Fed administration high marks in knowing just when to pause in that long series of 17 consecutive rate hikes.''

That kind of praise is a far cry from what Bernanke, a former Princeton University professor who served as a Fed governor from 2002 to 2005, was hearing earlier in the year.

Signaling the Pause

In April 27 testimony before Congress's Joint Economic Committee, Bernanke said the Fed might pause from its rate increases even if economic risks were still tilted toward higher inflation. His candor made him appear soft on inflation in the eyes of some bond investors, who sent the TIPS spread up 12 basis points in two weeks.

Two days later, at a Washington party, Bernanke told CNBC reporter Maria Bartiromo that markets had misinterpreted his remarks. Bonds and the dollar tumbled when CNBC reported the conversation with Bernanke on May 1. Questioned later about the incident during a congressional appearance, Bernanke described it as a ``lapse in judgment.''

``There is a presumption on Wall Street that the Federal Reserve is a competent institution, and there is a presumption that the chairman is a competent leader of that institution,'' said Neal Soss, chief economist at Credit Suisse in New York. ``Was it shaken to the point of breaking anything? No, it was not. Markets are very forgiving in that sense. They have a very short memory.''

A Note to Saxton

There was one more misstep: In a letter to Representative Jim Saxton, chairman of the Joint Economic Committee, Bernanke said inflation expectations were ``well contained,'' leading some investors to speculate he was disconnected from reality. Treasuries fell after the letter was released May 25.

With yields climbing, Bernanke came out on June 5 with his strongest anti-inflation language of the year, saying the latest price increases were ``unwelcome'' and that the Fed would ensure the trend wasn't sustained.

Since then, inflation has begun to recede, and the economy did slow to a 2.0 percent annual pace of growth in the third quarter without the benefit of additional Fed rate increases after June. Bernanke declined to comment.

Dangers Remain

Fed officials and some economists caution that the risks of inflation still outweigh those of slower economic growth or recession. That may be helping keep bond yields in check.

``A few months of favorable news on core inflation are not enough to declare victory,'' said Peter Morici, an economics professor at the University of Maryland in College Park.

While Bernanke may have established credibility on fighting inflation, he may still have room to shore up his reputation in other areas. Some scholars said a trip to Beijing this month, in which he appeared with a Bush administration team that pressed China to strengthen the yuan, may have compromised his independence.

``It was a hit on his credibility, but I don't think it's one that will damage him permanently if there are not repeated episodes,'' Morici said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.

Last Updated: December 28, 2006 00:10 EST