Dr Greenspan - acting as needed

Dr Greenspan's ever broader hints today about rate rises will be seen as a comfortable support for the "no suprises" approach to policy that the Fed seems anxious to maintain. For a market that has now firmly decided that economic recovery requires a return to more normal levels of interest rates and that the potential inflationary impact of rising commodity prices may also point to a rise in rates, the reality of a tightening will, nevertheless return us to the discussion about what level of interest rates is needed and at what level of steepness in the curve. For a properly constructed interest rate curve, an upward slope during an economic expansion is perfectly acceptable as it reflects the time cost of capital. (The fact that the UK has such a flat curve is a function of a distortive pricing of long term risk at short term rates via the housing market.) For those who grew up with the concept of the Taylor rule on real interest rates, the idea of a real rate of 2- 2.5% and a "normal" nominal short US rate of 4.5 - 5% probably underlies market expectations. This probably dictates that any rate rise will be met with a broad curve move and long rates adjusting in step with the short end. However, if one decides that the appropriate real rate for cash in such a disintermediated financial system is not a reward for holding cash but merely a maintenance in the value of money, a real cash rate could actually lie closer to 0.5-0.75%. Now with an inflation target of around 2%, the current 4.8% yield on the 10 year already implies an appropriately steep curve. If we see the Fed playing a calm, long game over the next month, then the reality of rate rises may well begin to be greated by Treasury rallies at the long end, not declines.