Bernanke must learn to walk the lineon loans rate rises

With bond yields touching new highs lately, the Federal Reserve faces a new dilemma: Raise rates too much and housing takes a dive. Stop too soon and inflation flares up. To avoid either outcome, Ben Bernanke, the new Fed chief, will have to walk the line between too much tightness and not enough.

Right now, the Fed’s more worried about rising prices throughout the economy than about falling prices in the housing sector.

Slack in the labor force and in industry is being used up at a rapid pace. Meanwhile, prices of industrial raw materials are jumping; gold’s at a 25-year high and oil is setting new records almost daily.

In reaction, long-term interest rates have surged to multi-year highs. The 10-year Treasury note has just broken through the 5% mark, while the reincarnated 30-year bond is well beyond this level.

Another way of gauging the fixed-income market’s sentiment towards inflation is to compare the yield on the standard 10-year Treasury note with that of its inflation-indexed version, known as TIPS.

The spread or difference between these two yields has begun to widen as people have started piling into TIPS, sending their prices up and their yield down. This widening gap between these two issues suggests that the market is no longer sanguine about the prospects for the future pace of price hikes.

Not surprisingly, this week’s U.S. inflation numbers will be scrutinized very carefully by central bankers to see if they herald the beginning of a new, higher rate, or are more of the same.

And you thought it was tough for Johnny Cash to walk the line.

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