Bernanke’s press conference marked the high point for rates this week, as the “new era of Fed transparency” failed to end the era of “extend and pretend”.

The Fed Chairman spent a large part of the Q & A portion shrugging off the latest rise in commodity prices - so much actually that the term “transitory” might very well be on its way to “conundrum” status. Greenspan used the term conundrum in 2005 to describe his inability to explain the situation of falling long-term yields in the face of rising short-term rates. The interest rate curve at the time caused concern for those who saw it as the market discounting inflation and economic growth in the future, while others explained it away as short term technical noise from increased foreign central bank demand for US Treasury Bonds driving prices up and yields down.

Inverted yield curves are highly correlated with recessionary periods, and although history says that curves need to be moderately inverted for a sustained period of time for the connection to be made, it was only briefly inverted before the credit crisis. Greenspan’s Federal Reserve failed to see what the yield curve was saying in 2006, and many argue that their policy led to the housing bubble and credit driven recession.

I’m not mentioning this piece of recent history because I think the most recent rise in commodity prices is a signal of impending doom, but I do think the Fed has an important decision to make. Their track record for explaining away market concerns by saying they are just temporary is not good.

Bernanke sighted increased foreign demand for commodities as a reason for the recent run up, which can certainly be to blame for a portion of the most recent rally, but there is more to the story than the Fed is willing to admit. I didn’t expect the Fed Chairman to blame it all on speculation fueled by negative real interest rates, but without mentioning it at all he blamed supply problems in the Middle East, which just isn’t true. There are certainly fears of supply disruptions if the chaos in Lybia spreads into larger oil producers like Saudi Arabia, but production throughout the Middle East is still continuing smoothly. The premium built into oil prices by problems in the Middle East is dwarfed by the cheap money rally in my opinion.

Bernanke gave speculators the green light by defining “extended period” as at least a couple FOMC meetings in his press conference. QE2 will still end in June, but the Fed has given no signal that they will let the size of their balance sheet fall below the $2.9 trillion level. (The post QE2 projected amount) Letting bonds mature without reinvestment would be considered tightening, but at this point it’s not looking like that will happen before a rate hike.

Have a great weekend.