Janet Yellen gets that sinking feeling Alan Greenspan once knew

NEW YORK: Alan Greenspan couldn't control long-term interest rates a decade ago, and bond investors are betting Janet Yellen's luck will be no better.
When then-Federal Reserve chairman Greenspan raised the benchmark overnight rate from 2004 to 2006, long-term borrowing costs failed to increase, thwarting his attempts to tighten credit and curb excesses that contributed to the worst financial crisis in 80 years.

“We wanted to control the fed eral funds rate, but ran into trouble because long-term rates did not, as they always had previously, respond to the rise in shortterm rates,“ Greenspan said in an interview last week. He called this a “conundrum“ during congressional testimony in 2005.

The bond market is signaling that past may be prologue as Yellen's Fed prepares to raise rates next year. The yield on the 10year US Treasury note has fallen 0.71 percentage point in 2014 even as the Fed wound down its bond-buying program and mapped out a strategy to raise the benchmark federal funds rate from near zero, where it has been since 2008.

Most Fed policy makers expect the central bank will raise the federal funds rate, which represents the cost of overnight loans among banks, some time next year, according to projections released in September.

The stakes are higher this time because rates are lower and the yield curve is flatter. Raising short-term rates in the face of stable or falling long-term rates could lead to a situation where the Fed “quickly inverts the yield curve and turns credit An inverted yield curve occurs when short-term securities yield more than longer-dated bonds. That discourages banks from extending credit because they finance long-term loans with short-term debt. Inverted yield curves typically precede recessions.