Bond markets are jittery and investors have reasons to be nervous.
The decision last week by the U.S. Federal Reserve Board to raise the discount rate - the interest it charges on the emergency loans it makes to banks - suggests the days of easy money marked by the Fed's zero-interest rate policy are numbered.
The Fed raised the discount rate by one-quarter of a percentage point, to 0.75 per cent.
While that signals another step in the return of financial markets to a more normal state, given the weak economy it will likely be some time before the Fed begins to raise its key federal funds rate. That is the rate that helps to hold short-term interest rates down in order to stimulate economic growth.
And it is that policy that has bond investors antsy. The worry is that the continuing low interest rate and loose monetary policies of the Fed will fuel inflation.
So far, inflation pressures as measured by the consumer price index have been relatively tame, if rising gasoline and food prices are excluded. The U.S. core consumer price index (excluding food and energy) on a year-over-year basis was 1.6 per cent in January, compared with 1.8 per cent in December.
However, overall the annual inflation rate is 2.6 per cent, reflecting higher gasoline prices and the beginning of higher food prices resulting from the impact of the Florida freeze on fruit and vegetables, according to BMO Nesbitt Burns Inc.
Bond investors are being torn between the safety of holding U.S. Treasuries and the risk of seeing their savings eroded by inflation. Recent action in the bond markets illustrates the forces at work.
The short-term action has been dramatic.
