MNI EXCLUSIVE: Fed May Consider Yield Caps, Seen Wary For Now

By Evan Ryser and Jean Yung

     WASHINGTON (MNI) - The Federal Reserve is likely to further explore

adopting caps at the front end of the yield curve later this year, former Fed

officials told MNI, though they were divided as to its efficacy and expected the

central bank to remain wary of the policy at least in the near term.

     Yield curve control is among remaining policy options that could be

considered later in 2020, said former Atlanta Fed President Dennis Lockhart,

adding that it would, if enacted, enhance control of longer-dated maturities and

help support a recovery in housing, autos and other consumer markets. However,

currently the shape of the yield curve and spreads between maturities are not

contributing to suppress economic activity, he noted.

     Steven Friedman, former director of market analysis at the New York Fed,

said a policy of "capping yields out two or three years would be very beneficial

for the Treasury keeping funding costs low," together with forward guidance.

     But some officials are apprehensive about making a commitment which if they

fail to meet it would risk serious damage to Fed credibility.

     While Roberto Perli, former Fed economist and a partner at Conerstone

Macro, agreed that the Fed might eventually decide to target rates on bonds of

up to two or three years' maturity, he noted that "yield curve control would

require some heavy lifting in the Committee."

     "I wouldn't exclude it eventually, but this year seems soon to me," Perli

said.

     Yield curve control - last adopted in the 1940s and debated within the FOMC

since the financial crisis - would lead the Fed to purchase not a pre-set quota

of bonds but as many as necessary to bring them back in line if they rose past a

certain limit. The Bank of Japan has used the policy and Australia recently

adopted it.

     -- HEAVY LIFTING

     Joseph Gagnon, a former Fed official currently at the Peterson Institute

for International Economics, cast doubt on whether yield curve control gets "an

outcome that's much different" from large-scale asset purchases.

     "We have no idea what's going to be appropriate six months from now, let

alone 12 months from now," Gagnon said. "It could be needed at some point if we

really have to put the pedal to the metal but it's just not clear that the

economy's going to be lacking enough aggregate demand going forward."

     If yields start to rise then the Fed would rather opt to step up asset

purchases and "slap it back down," Gagnon said.

     Chair Jerome Powell Apr. 9 indicated the Fed's focus would be on

implementing its many emergency facilities before moving on to consider yield

curve control. Fed Governor Lael Brainard in a February 21 speech noted the

advantages of yield curve control when complemented by forward guidance, and

Dallas Fed leader Rob Kaplan told MNI in mid-February that the Fed should at

least be "open" to it.

     -- EXIT STRATEGY

     The exit strategy from yield curve control would be "an issue," according

to Perli.

     "The exit is going to be complicated regardless of what instrument they

use," he said. "I don't think they are going to unwind Treasuries for the

foreseeable future - ever, and longer. We need to redefine what normal is in

terms of what the Fed balance sheet is, and I would think going to yield curve

control would complicate things even more."

     Gagnon added: "That exit process is going to be kind of messy. They are

worried about that, and so they would rather do what they're doing."

     No other central bank has exited from yield curve control in recent times,

but the Fed from 1942 until 1951 capped yields on Treasury securities to help

finance wartime spending. A recently released New York Fed blog noted that

fixing the level of Treasury yields forced the Fed "to buy whatever private

investors did not want to hold at the fixed rates," and eventually led to the

1951 Treasury-Fed accord.

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

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