A ‘Buy Everything’ Stock Rally – Yield Curve Control

Federal Reserve Chair Jerome Powell said the usefulness of the policy “remains an open question” on June 10.
With new FED measures, stocks stand to surge for a new rally

What is yield-curve control?

The yield curve (YCC) is the relationship between rates on bonds of varying durations. Investors generally demand a higher yield for holding longer-term debt, meaning that the curve is normally upward sloping. And normally, central banks manage monetary policy through short-term rates only: The Fed, for instance, creates incentives to keep overnight borrowing within a range it specifies — what’s known as the Fed Funds rate. In a policy of yield-curve control, the central bank also sets a target yield for one or more specific maturities of government debt.

How does it do that, and what does that do?

A central bank pursuing yield-curve control will announce its target rates and maturities — and that it will buy those securities in whatever amounts are necessary to peg the rate there. As well as capping longer-term borrowing costs for the government, this will bring down rates for businesses and consumers. The policy also helps convey the message that benchmark short-term rates will be staying low, according to some Fed officials.

Should yield curve control go global, it would cement markets’ perception of central banks as the buyers of last resort, boosting risk appetite, lowering volatility and intensifying a broader hunt for yield. While money managers caution that such an environment could fuel reckless investment already stoked by a flood of fiscal and monetary stimulus, they nonetheless see benefits rippling across credit, equities, gold and emerging markets. Of course, such a widespread bullish outlook comes with risks, especially at a time when asset valuations are near extremes. A rally in U.S. stocks has pushed estimated price-to-earnings to the highest in almost two decades. It’s a precarious bubble that could eventually burst, should the wall stimulus spur inflation down the road and eat into investors’ profits.

JULY 1 2020: FEDERAL RESERVE RELEASES MINUTES FROM JUNE 9-10 POLICY MEETING

  • MEMBERS AGREED FED WAS COMMITTED TO USING ITS FULL RANGE OF TOOLS TO SUPPORT THE U.S. ECONOMY
  • DISCUSSED WHETHER YIELD CURVE CAPS OR TARGETS COULD SUPPORT FORWARD GUIDANCE AND “COMPLEMENT” ASSET PURCHASES
  • PARTICIPANTS AGREED THAT THE DATA FOR THE SECOND QUARTER WOULD LIKELY SHOW THE LARGEST DECLINE IN ECONOMIC ACTIVITY IN POST–WORLD WAR II HISTORY
  • STAFF ECONOMIC SIMULATIONS SUGGESTED THAT FINANCIAL CONDITIONS WOULD NEED TO BE HIGHLY ACCOMMODATIVE “FOR MANY YEARS” TO MEANINGFULLY QUICKEN THE RECOVERY
  • FED STAFF PRESENTATION SAID LIQUIDITY CONDITIONS CONTINUED TO IMPROVE IN GENERAL, BUT SOME STRESS WAS STILL EVIDENT IN SEVERAL FINANCIAL MARKETS
  • STAFF REVIEW OF YIELD CURVE TARGETS INCLUDED REVIEW OF U.S. EXPERIENCE IN WORLD WAR II, CURRENT POLICIES USED IN JAPAN AND AUSTRALIA
  • A NUMBER OF PARTICIPANTS JUDGED FORWARD GUIDANCE ON RATES AND BOND-BUYING SHOULD AIM TO SUPPORT RAPID ECONOMIC RECOVERY, FOSTER ‘DURABLE’ RETURN TO 2% INFLATION
  • PARTICIPANTS EXPECTED SOCIAL DISTANCING, SAVING AND LOWER LEVELS OF EMPLOYMENT AND INCOME TO RESTRAIN THE PACE OF EXPANSION OVER THE MEDIUM TERM
  • A “NUMBER OF PARTICIPANTS” SPOKE IN FAVOR OF TYING FORWARD GUIDANCE TO INFLATION GOALS ALLOWING A “MODEST TEMPORARY” OVERSHOOT OF 2% TARGET
  • FED STAFF SAID A SECOND WAVE OF THE CORONAVIRUS OUTBREAK WAS NO LESS PLAUSIBLE THAN THEIR BASELINE FORECAST SCENARIO AND IF IT OCCURRED, ECONOMIC DISRUPTION WOULD BE MORE SEVERE AND PROTRACTED
  • A FEW PARTICIPANTS NOTED THAT CURRENT LOW RATES OF INTEREST MIGHT LIMIT EFFECTIVENESS OF FURTHER ASSET PURCHASES BEYOND THOSE NEEDED FOR MARKET FUNCTION; A FEW WORRIED ABOUT IMPACT ON FINANCIAL STABILITY
  • IN DISCUSSION OF YIELD CURVE TARGETS, “NEARLY ALL PARTICIPANTS” HAD “MANY QUESTIONS” ABOUT THE COSTS AND BENEFITS OF SUCH AN APPROACH. PARTICIPANTS “GENERALLY SAW” AUSTRALIA’S EXPERIENCE AS MOST RELEVANT TO THE U.S.
  • PARTICIPANTS RAISED “A NUMBER OF CONCERNS” OVER WHETHER THE FED COULD KEEP CONTROL OVER THE SIZE AND COMPOSITION OF ITS BALANCE SHEET WHILE ALSO SETTING A YIELD CURVE TARGET
  • OTHER CONCERNS INCLUDED DIFFICULT OF EXITING A YIELD CURVE TARGET, POSSIBLE RISKS TO CENTRAL BANK INDEPENDENCE, AND IMPACT ON PRIVATE MARKETS
  • “A COUPLE OF PARTICIPANTS” DEFENDED AN “APPROPRIATELY DESIGNED” YIELD CURVE TARGET AS A “POWERFUL COMMITMENT DEVICE”
  • ALL PARTICIPANTS AGREED TO CONTINUE STUDYING YIELD CURVE TARGET POLICIES

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