MNI EXCLUSIVE: Fed Mulls Asset Buys, Short Yield Cap Benefits

By Evan Ryser

     WASHINGTON (MNI) - The Fed is set to debate its record Treasury purchases

and the benefits of capping yields to help markets through Covid-19, with former

officials telling MNI it's easiest to fix rates on short-term bonds.

     While yield caps could give markets a boost with policymakers reluctant to

adopt negative interest rates, former officials said the Fed is unlikely to

follow the Bank of Japan's limits on medium-term debt. 

     "It's debatable whether they can cap yields" very far out the curve, former

Dallas Fed President Richard Fisher said. The debate will become more focused as

the year progresses and the outlook becomes clearer, he said. 

     Yield caps are "most likely" credible to the market on the short-end at

first according to Roberto Perli, former Fed economist now a partner at

Cornerstone Macro. If markets see the short-term cap as credible, it makes it

easier for the Fed to focus its bond buys further out the curve, he said.

     Vincent Reinhart, former director of the division of monetary policy at the

Fed, suggested caps could be dangerous if the market tests them and the Fed has

to buy more Treasuries than policymakers imagined.

     --HOLDING THE KITE

     While it has been more natural for the Fed to spread asset purchases along

the curve, short-end caps may come into play if those yields surged even as the

economy performed poorly. "That would be presumably because the debt issuance

was pushing up yields and that inflation must have been rising... that's not a

world we want to live in," he said.

     "It's unlikely that the Fed would be capping the 2-year Treasury note yield

but not do anything for the 10-year," Reinhart added. "It would risk having the

longer-end of the yield curve flapping in the wind as the Fed is holding to the

first part of the kite."

     The Fed's April meeting minutes show "a few participants" support capping

short- to medium-term maturities, while "several participants" noted the need to

provide further clarity for long-end Treasury buys. Vice Chair Richard Clarida

has said staff will be briefing the FOMC over yield cap policies "down the

road."

     Peter Hooper, global head of economic research at Deutsche Bank who

previously spent 26 years at the Fed, said he expects the Fed to adopt caps on

2- or 3-year rates in the fall or in early 2021.

     --GUIDANCE

     One argument against caps is record low government bond yields this year,

meaning less of a jolt from Fed moves to push them down further. 

     "Considering the fact that there is powerful demand from the private sector

for Treasury securities, that are a classic safe haven, I don't really see a

meaningful back up in rates," Perli said. An improvement in the outlook,

however, and a shift out of safe havens might cause rates to inch back up.

     If yields move up, Reinhart said, Chair Jerome Powell would "try to talk it

out of the economy" before moving to QE. "Powell would get up in a press

conference and say, 'does anyone here plausibly believe that we tighten monetary

policy when we have an unemployment rate that is double digits,'" Reinhart said.

     By explaining how persistent the economic problem is, Reinhart said, Powell

has solved the forward guidance problem. If the Fed adopts yield caps, "they do

it reluctantly and at a time of considerable distress," he said.

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

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