CONUNDRUM- (ku-nun'drum), noun. 1. a riddle, the answer to which involves a pun or play on words, as What is black and white and read all over? A newspaper. 2. anything that puzzles.

That is the word being used by some FED Governors to describe the current relationship between the 10 year Treasury note and the Fed Funds rate. Longer maturity interest rates have fallen sharply since the Fed embarked on its tightening program at the short end of the yield curve. Yields on 10-year notes (US10YT=RR) are currently at 3.90 percent, down from about 4.85 percent in June 2004 when the Fed started raising rates.

The riddle market participants are wrestling with is "why is the interest rate on the 10 year Treasury note declining while the Federal Reserve Bank raises interest rates?" What is most unusual about this conundrum is that there does not seem to be anyone who knows the answer. Some market pundits have tried to explain why this is happening, but no one has good answer to the riddle. The market riddlers have pushed interest rates lower without explanation, which is confounding the very masters that set those rates.

Safety is always a good reason to buy US Treasury notes, so demand due to some kind of fear may answer part of the riddle. Some economist types think that the "flattening of the yield curve", which is what has happened, is signaling the onset of a recession. Others blame hedge funds being forced into or out of tightly wound and very wrong hedges, better known as bets. Still others blame the insatiable appetite that foreigners have for our Treasuries triple A debt.

Most Wall Street veterans find it a bit unnerving that the market is defying the FED actions. Forces being what they are, many very smart and very visible Wall Street gurus have been very wrong on the 10 year Treasury, so things are likely to get even more "conundrummy" before we know the answer to this puzzle.

At some point the answer to the riddle will be known. Federal Reserve Governor Susan Bies took on the "conundrum" of the disconnected long-term U.S. interest rates in comments to reporters after speaking at a Women in Housing and Finance event in Washington. "I honestly don't know what it's going to take. It just appears that long-term rates cannot stay at this low level," Bies said. Governor Bies added "At some point we do believe that the 10-year Treasury (note yield) will rise and take mortgage rates with it," Bies said. Michael Mandel from the NY Times says..."It's like living in a parallel universe. Surprising most economists, mortgage rates have gone down in recent weeks rather than up.”

With the 10 year Treasury below 4 percent and next FOMC meeting being held in late June, and the next 1/4 percent rate rise is forecast taking the Fed Funds rate to 3.25 percent, an inverted yield curve is not far off. For those that do not know, that's not a good thing. All the financial companies that are being affected by this conundrum as interest rates that they pay for their funds rise and they are unable to raise the rates they charge to borrowers due to the market forces that have pushed rates down. Banks will get squeezed and credit risk will rise. Banks and other lenders are being faced with slowing volumes and lower margins, a combination that is very bad for profits.

The big question is how does this conundrum get resolved? Will the FED get more aggressive to get the result it wants? Will the market adjust on its own in an orderly fashion? Will foreign buyers of US Treasuries balk at the low rates being paid? Will hedge funds with huge losses stick around for the answer or will they get forced out against their better judgment? Will any of this matter to the housing market or the stock market?

Stay tuned, because the answer to these and many more questions are sure to be answered in the coming weeks.