Fed: anchoring low capital market yields

On 9 and 10 June, the Council of the US Federal Reserve will meet. At the forthcoming FOMC meeting, the US currency watchdogs are likely to discuss in depth the possibility of so-called „yield curve control“. As in Japan, yield targets for certain, generally longer maturities will be set by the Federal Reserve. Also on the agenda are the revised projections, a possible concretization of the forward guidance and the question of whether the Fed will make statements about the amount of future bond purchases. Given a key rate corridor of 0.00%-0.25%, no changes are to be expected in this regard.

In various speeches the Fed’s upper echelons have recently discussed how they can anchor capital market yields at a low level in the medium term. However, whether the Fed will actually dare to make the paradigm shift and switch to yield curve management is not only questionable, but in our view unnecessary in the current environment. For example, capital market yields in the United States are already very low. Last but not least, the Fed has the option of unlimited bond purchases, which means that it can guarantee low yields even without explicit yield curve management. Moreover, the effects on the real economy of the Fed’s most recent expansionary steps cannot yet be determined, because only in recent weeks have the quarantine measures been slowly eased. Ultimately, in our view, the introduction of a yield curve management system at the forthcoming FOMC meeting would amount to a „waste of monetary policy options“.

With the forthcoming publication of the quarterly economic outlook, the Fed has another option to keep capital market yields low. For example, the guardians of the currency could hold out the prospect of a zero key rate for the coming years within the framework of so-called dot plots. In our view, the guardians of the currency will revise their interest rate expectations substantially downwards. Already in its forward guidance, the Fed had promised to keep key rates at zero until the FOMC „is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price targets. This is interpreted by the financial markets as meaning that the zero interest rate level will remain in place for the foreseeable future.

There is no doubt that in the quarterly economic forecasts, economic development and inflation rates will be drastically lower than in the previous projections. The question arises as to how quickly the jobs lost in the pandemic can be regained. On the one hand, this depends on how many companies will file for bankruptcy due to the forced closure. On the other hand, the pandemic could accelerate structural change in the retail, hospitality and labour-intensive services sectors. Against this background, the unemployment rate could remain high for a longer period of time and wage pressure could remain low for the time being.

In addition to the projections, the central bank has a more effective way of controlling yields over the entire yield curve: bond purchases. If the central bank wants to keep capital market yields low, especially at the long end of the curve, it could consider an operation twist or focus on longer maturities when buying government bonds. In an Operation Twist, the central bank would swap bonds in its portfolio with a maturity of less than two years for longer-term US Treasuries. Given the slightly steeper yield curve in recent weeks and since two-year yields are below 20 basis points, this would be a possibility. However, we can also well imagine that the Fed will only pull this option if yields rise above the 1% mark as the economic recovery sets in. To sum up, we can say this: For the foreseeable future, we do not expect the Fed to abandon its ultra-expansive monetary policy.

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