Federal Reserve Chairman Alan Greenspan calls it a "conundrum." Former Fed colleague Laurence H Meyer calls it "extraordinarily unprecedented."

The Fed has raised its target interest rate six times since June 30, intending to prevent the US economy from overheating later this year. Instead, the increases are having the opposite effect: They are spurring the economy, not reining it in.

"Rather than the rate hikes slowing the economy as some analysts had expected, they've acted as a stimulant," said David Malpass, chief economist at Bear, Stearns & Co in New York.

When the Fed raised the overnight bank-lending rate in the past, long-term interest rates rose as well. This time around, investors took comfort in the Fed's commitment to what it calls a measured pace of rate increases as a way to head off faster inflation.

Instead of rising, yields on 10-year Treasury securities and rates on 30-year mortgages fell. Banks expanded their corporate lending and merger activity sped up.

"This is a unique experience," said Meyer, a Fed governor until 2002. "From the very moment the Fed began to tighten, long rates are falling. In 1994, the last time the Fed raised the rate significantly, "long-term rates just shot up much more than most people were expecting," he says.

Greenspan, in his final year atop the central bank, told Congress last week he is puzzled. The yield on the benchmark 10-year Treasury note has fallen more than 30 basis points to about 4.27 per cent since June 30, the first of six straight meetings in which the Fed raised its target rate by a quarter-point to the current 2.5 per cent. Gary Pollack, head of fixed income trading and research at Deutsche Bank Private Wealth Management in New York, which manages US$12 billion of bonds, says that a yield reflecting the fundamentals of the economy and inflation would actually be between 4.5 per cent and 4.75 per cent.

"Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience," Greenspan said in the text of his testimony to the Senate Banking Committee on February 16 and the House Financial Services Committee on February 17. "The broadly unanticipated behaviour of world bond markets remains a conundrum."

The benchmark 4 per cent note maturing in February 2015 was little changed at 97.84 at 2:32 pm in Tokyo, according to bond broker Cantor Fitzgerald LP.

The unexpected booster shot creates a risk that easy money will spur growth, which in turn may accelerate inflation, Richard Berner, chief US economist at Morgan Stanley in New York, said in an interview. Faster inflation is the very thing the Fed wanted to head off with higher interest rates.

Keeping inflation at bay would mean "short rates are going to have to go up considerably," Berner said.

Among signs suggesting the rate increases have not damped consumer or corporate spending: Bank lending for commercial and industrial loans surged 6.6 per cent since May 5, the month before the Fed began tightening. Mergers and acquisitions in this year's first six weeks reached the fastest pace since 2000. Housing starts unexpectedly rose 4.7 per cent in January to a 21-year high after a 14 per cent surge in December. The 30-year fixed-rate mortgage two weeks ago dropped to a 10-month low of 5.48 per cent.

"It's an ideal time to put money to work," Paul Beard, treasurer at Sparks, Maryland-based McCormick & Co Inc, the world's largest spice company, said in an interview. "The feeling is that rates are going to continue to rise."

Growth forecasts are rising accordingly.

(China Daily 02/23/2005 page12)