Powell and his colleagues have been pushing for lawmakers to step up with fiscal stimulus, stressing that monetary policy can only do so much to combat the long-lasting effects of the pandemic. Yet if the stalemate in Washington persists, it could lead the Fed to do more.
Minutes of the Fed’s September gathering signaled a readiness to examine the bond-buying program and possibly alter or increase the purchases, on top of keeping policy rates near zero at least through 2023. Officials suggested they might shift some purchases toward longer-term debt to create a bigger downward force on rates. They’ve downplayed the idea of yield caps, but most economists still see it as a possible tool.
Jim Caron at Morgan Stanley Investment Management says he’s “slowly taking advantage” of buying opportunities when 10- or 30-year Treasury yields rise. He predicts the 10-year rate will get no higher than 1.25% and expects the Fed won’t lift rates until at least 2024 or possibly 2025.
“Interest rates are going to be low for an extended time, so that means a limited backup in rates,” he said. “We still own Treasuries and would be happy to buy more if rates rise and overshoot our upside expectations.”
Fed actions have also fostered demand for Treasuries from U.S. banks and foreign investors. U.S. commercial banks have ramped up holdings since the Fed eased some regulatory requirements in April in hopes of reversing a liquidity shortfall.
“If the U.S. recovers more quickly on the back of robust fiscal stimulus, and presumably a vaccine, we could see a move up in yields,” said Alex Etra, a senior strategist Exante Data who formerly worked at the New York Fed. “But if you got a really rapid ramp-up that was at risk of derailing the recovery, that’s certainly a case where the Fed would step in,” he said, noting policy makers’ discussions last month on extending the duration of the Fed’s Treasury portfolio.
“That’s not exactly yield-curve control, but it clearly is intended to reduce the probability that long-term yields rise,” he said.
Any increase in yields should also draw foreign investors, with over $16 trillion of global investment-grade debt yielding less than zero. With hedging costs having cheapened and the U.S. yield curve steepening, the pick-up on 30-year Treasuries for euro-hedged investors is roughly 80 basis points above German bunds.
The Fed’s move this year to bolster currency swap lines has helped make the pricing more attractive for currency hedgers, says Zoltan Pozsar at Credit Suisse Group AG. And while central banks have stepped back from the swaps, the lines still create a backstop to keep hedging costs down.
“There are two policeman that will keep long-end Treasury yields from moving too high: the Fed and the foreign buyers, which can obtain cheap currency hedges through the Fed’s swap lines,” Pozsar said. “It’s Fed policing ultimately, either way.
--With assistance from Vivien Lou Chen, Edward Bolingbroke, Elizabeth Stanton and Stephen Spratt.
This article was provided by Bloomberg News.