Doubts about Fed policy drive up yields on bonds

Call it the "Bernanke premium."

Traders in the U.S. bond market have added about 10 basis points, or 0.1 percentage point, to Treasury yields because they're concerned the Federal Reserve, led by Chairman Ben Bernanke, will fail to contain inflation or send clear signals on the direction of interest rates.

Ten basis points cost the government an additional $1 million in annual interest on every $1 billion it borrows.

Bernanke raised doubts among investors twice recently. Treasury prices fell after he told a reporter at a party last month that the market had misunderstood his remarks to Congress signaling the Fed might pause in its two-year campaign of raising rates.

They dropped again last week when he said inflation expectations are "well-contained."

"There's a Bernanke premium in the market," said Gary Pollack, head of fixed-income trading for Deutsche Bank's investment-management unit in New York, which manages $11 billion in bonds. "We have a new Fed chairman and an uncertain Fed policy," he said.

Yields on 10-year Treasuries barely rose as the central bank boosted rates 14 times between June 2004 and Feb. 1, when Bernanke took over from former Chairman Alan Greenspan. Since then, the benchmark note's yield increased 53 basis points and is 2.95 percentage points more than the core rate of inflation, the highest so-called real yield since December 2003.

"You want protection to the extent inflation may be picking up here," said James Keegan of New York-based American Century Investments.

Ten-year yields rose above 5 percent last month for the first time since 2002. Treasuries of all maturities have lost 1.34 percent this year, the most since 1999, according to Merrill Lynch's U.S./Treasury Master Index.

While the benchmark 10-year Treasury was little changed last week, prices are becoming more volatile. The Merrill Option Volatility Estimate Index last week rose to 71.9, the highest since February. The index indicates investors expect yields to rise or fall as much as 72 basis points over the next 12 months.

"Investors don't know whether he'll stay the course and tame inflation," said Barr Segal of Los Angeles-based TCW Group. Besides being fresh to the job, Bernanke, 52, also faces the challenge of containing inflation at a time when prices of commodities such as zinc, oil and aluminum are at or near record highs.

Traders in the $4.2 trillion market for U.S. government debt questioned Bernanke's communications after a Commerce Department report Friday showed the government's price index for items excluding food and energy rose 2.1 percent in April from a year earlier.

A day earlier, Treasuries fell as some traders focused on Bernanke's addition of the word "well" when describing inflation expectations as being "contained" in response to questions from Congress' Joint Economic Committee. Traders interpreted the change from policy statements since Sept. 20, that only said expectations "remain contained," as a sign Bernanke isn't concerned about rising commodity and labor costs.

Bernanke testified before the same group last month that "the committee may decide to take no action at one or more meetings" and wait for more economic data before raising rates even if there are signs of inflation.

Traders took the comments as a sign the Fed was preparing to pause. Bernanke then told CNBC reporter Maria Bartiromo at an April 29 party that the market misunderstood him.

Yields on 10-year Treasury notes rose 9 basis points after the report, sparking an uproar because the comments weren't made in a formal Fed communication.

The Fed chairman told the Senate Banking Committee this month the remarks were "a lapse in judgment" and that he would use "regular and formal channels" in the future.

The Bernanke "premium" probably amounts to an extra 5 to 10 basis points in yield, said Mitchell Stapley, who oversees $21.9 billion as chief fixed-income officer at Grand Rapids, Mich.-based Fifth Third Asset Management.

"You talk about presidents having a honeymoon period," Stapley said last week. "There doesn't seem to be any honeymoon period for Fed chairmen."

Greenspan's statements were often deemed obtuse and offered little clarity about how the Fed determined what was important.

"Now we're getting that clarity and we're finding it's not as easy as it sounds," Stapley said.