Cracking the Conundrum

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Abstract
Between June 29, 2004, and February 2, 2005, the Federal Open Market Committee increased the target federal funds rate by 150 basis points (bp), or 1.50 percentage points. Over the same period, the long end of the yield curve fell, with the ten-year yield declining by 70 bp and the ten-year (instantaneous) forward rate by more than 100 bp. This pronounced rotation in the yield and forward rate curves caught many by surprise. Then- Federal Reserve chairman Alan Greenspan was one. In his February 2005 testimony to Congress, he noted:1

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