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Interest rate rise puts Fed in bind


NEW YORK -- Long-term interest rates shot sharply higher for the second day in a row yesterday, leaving the nation's central bank in a bind that it is probably finding very uncomfortable.

Federal Reserve Chairman Alan Greenspan is likely to face some hard questions -- and criticism -- from Congress on Tuesday when he presents his annual review of the bank's interest-rate policy.

The Federal Reserve raised short-term interest rates Feb. 4 for the first time in five years in an effort to get a step ahead on any jump in inflation and to convince traders and investors that the central bank's anti-inflation vigilance was beyond reproof.

But in the two weeks since the rate action, it appears that rather than reassuring traders and investors, the Federal Reserve has managed to leave them with a worse case of the jitters.

The financial markets seem to have increased their focus on inflation amid a consensus that the Federal Reserve will have to raise short-term interest rates again soon. Both factors have led to a sharp sell-off in the bond market and a jump in both long- and short-term interest rates.

The yield on the 30-year bond rose to 6.62 percent yesterday, from 6.54 percent Thursday. That yield is the highest since July and a third of a percentage point higher than it was on Feb. 4, when the Federal Reserve pushed short-term interest rates up a quarter of a percentage point, to 3.25 percent.

"The interest rate hike validated the market's inflation fears," said Matthew F. Alexy, a government securities specialist at CS First Boston. "The market must have asked itself: Why would the Fed move to raise interest rates unless there was, in fact, a problem with inflation?"

The Federal Reserve has created a problem for itself, Mr. Alexy contended, and "now will have to take the next step to correct the problem." That step, he said, is another increase in short-term interest rates.

Every increase in the yield of the 30-year bond, he said, heightens the chance that the Federal Reserve will push short-term rates higher in an effort to convince investors that the central bank will fight inflation.

"It's a very tricky path the Fed has started to march down," he said.

Donald Fine, chief market analyst at Chase Securities, said the Fed's rate increase on Feb. 4 "is being interpreted rather wimpishly."

"Now everyone assumes that another quarter point is coming," he said, "and it is hard to go out there and be bullish when the Fed is raising interest rates again."

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