Bond Market Dilemma: Comparing Anticipated Inflation versus Long-Term Bond Yields - The Second Perplexing Paradox
Rewritten Article:
In the early 2000s, a significant economic puzzle — commonly known as "The Great Conundrum" — unraveled. This dilemma emerged following the 2001-2002 sharp drop in the S&P 500 and the commencement of Gulf War II in March 2003.
Contrary to common belief, Alan Greenspan didn't promptly jack up the federal funds rate after the market tumble or the war's kickoff. Instead, economic recovery necessitated lower interest rates in 2003, as evidenced by the Fed's actions[1][2].
It wasn't until 2004 that Greenspan raised the federal funds rate. As the economy regained strength and concerns about inflation cropped up, monetary tightening became inevitable[1][2]. This economic phase was marked by the flattening of the Treasury yield curve, a situation that would later be referred to as "the Great Conundrum" by Greenspan due to the puzzling behavior of long-term Treasury yields in spite of the strict monetary policy[1][2].
[1]: Greenspan, A. (2006). The age of turbulence: Adventures in a new world, 1995-2005. Penguin.[2]: Bernanke, B. S. (2015). The Federal Reserve and the financial crisis. Princeton University Press.
- In contrast to the post-2001 financial crisis and the Gulf War II, Alan Greenspan did not immediately increase the federal funds rate in 2003, even though hiking might have been expected given the economic circumstances.
- In 2003, the Federal Reserve, under Greenspan's leadership, chose to lower interest rates in spite of the global financial conundrum that was unfolding, a decision that would later be justified by the economic recovery that followed.
- After the economy had regained strength in 2004, Alan Greenspan, reflecting on the peculiar behavior of long-term Treasury yields during the recovery period, referred to the flattening of the Treasury yield curve as "The Great Conundrum," suggesting a confounding phenomenon in the world of finance and investing.
