Bernanke Says Unwinding of Risky Bets Boosts Borrowing Costs

Federal Reserve Chairman Ben S. Bernanke said rising bond yields partly reflect an unwinding of leveraged and “excessively risky” investments, calling the tighter financial conditions “unwelcome” as monetary policy stays highly accommodative.

The Fed chief, in testimony before the Senate Banking Committee, said the increase in borrowing costs over the past two months is related to “better economic news,” Fed communications about tapering its $85 billion monthly asset purchase program and changing bond-market bets.

The unwinding of risky bets is “probably a good thing to have that happen although the tightening that’s associated with that is unwelcome,” he said in response to a question from the committee during his second day of congressional testimony.

Fed officials plan to reduce the pace of asset purchases over the next year if the economy performs in line with their forecasts, which see growth picking up through the end of 2013. The economy probably expanded less than 1 percent in the second quarter, according to St. Louis-based Macroeconomic Advisers LLC, and a sustained rise in borrowing costs could threaten the four-year expansion.

Treasury yields fell yesterday as the 59-year-old Fed chairman held out the possibility that the Fed could delay tapering if the economy loses momentum. Michael Feroli, chief U.S. economist for JPMorgan Chase & Co. in New York, said the Fed probably will keep its tapering plans intact as concerns reflected in long-term rates ebb.

Risky Positions

“To the extent it was an unwind of leveraged positions, that should be essentially a one-time event, so you kind of shook those positions loose and presumably that won’t happen again,” said Feroli, a former Fed economist. “They seem to have done now a pretty good job of separating tapering from tightening and if they keep that up, it should limit any change in expectations of forward rates.”

Fed officials have said that a reduction in the monthly pace of bond buying wouldn’t represent a tightening of policy, and that the benchmark interest rate will stay low after the purchases end.

The yield on the 10-year Treasury note rose to 2.53 percent at 2:20 p.m. in New York from 2.49 percent late yesterday. Ten-year note yields touched a two-week low yesterday after Bernanke told the House Financial Services Committee that the central bank’s bond purchases “are by no means on a preset course” and could be reduced more quickly or expanded as economic conditions warrant.

Higher Rates

The yield has risen from 1.93 percent on May 21, the day before Bernanke said the Federal Open Market Committee may trim its bond buying in its “next few meetings” if officials see signs of sustained improvement in the labor market.

Relative yields on dollar-denominated junk bonds rose as much as 107 basis points over Treasuries of similar maturity after Bernanke’s May 22 Joint Economic Committee testimony. The yields climbed to 534 basis points on June 24, before declining to 468 basis points as of July 17, according to Bank of America Merrill Lynch index data.

Spreads on investment-grade notes swelled as much as 31 basis points in the period, to 172 basis points on June 24, before dropping to 157 basis points over Treasuries of similar maturity, the data show. A basis point is 0.01 percentage point.

The tapering timeline will depend on a boost in third-quarter growth after weak data in the second, including trade, inventories and the consumer purchases that make up about 70 percent of the economy.

Growth Forecasts

Macroeconomic Advisers, which updates its estimate of gross domestic product with each new piece of data, now forecasts the economy grew at a 0.7 percent annual rate in the second quarter, down from a 1.7 percent estimate at the start of July. The world’s largest economy expanded at a 1.8 percent pace in the first quarter.

The economy will expand at a 2.3 percent pace in the third quarter and 2.6 percent in the final three months of the year, according to the median of 68 responses in a Bloomberg survey of economists conducted July 5 to July 10.

In testimony today and yesterday, the Fed chief sought to reassure investors that even as the central bank considers a reduction in asset purchases, it has not changed its highly accommodative policy.

“We are not talking about tightening monetary policy,” Bernanke said. “I want to emphasize that none of that implies that monetary policy will be tighter at any time within the foreseeable future.”

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