The White House and Democratic leaders are arguing over how much additional money is needed. Key parts of the government rescue effort, like extra unemployment benefits, have begun to expire –- a potential drag on demand, just as a resurgent virus sets back efforts to reopen the economy.
All these background risks explain why the Fed isn’t thinking about hitting the brakes at the first sign of higher prices.
In fact, the Fed’s soon-to-be-completed review may formally abandon the strategy of launching preemptive attacks against inflation –- and replace it with one that’s more tolerant when prices overshoot for a while, provided the 2% target is on track to be met over a longer period.
After Labor Day
While the Fed can get some results by rejigging its policy framework or telegraphing its intentions -- known as “forward guidance” in central-bank jargon -- it may eventually have to buy more bonds too.
The current monthly purchases of about $80 billion Treasuries have kept a lid on government borrowing costs -– and fed into the wider economy, where those yields are a benchmark. Mortgage applications have jumped.
But this month the market has shown signs of struggling to digest the record quantities of public debt issued to fund the pandemic rescue.
Ten-year nominal Treasuries are trading at around 0.67%, up 14 basis points from the end of July. Borrowing costs for homebuyers nudged higher too: Freddie Mac’s 30-year fixed mortgage rate rose to 2.96% in the week ended Aug. 13, from a record low of 2.88%.
Central banks have tried two main ways of using bond purchases to suppress long-term interest rates: Quantitative easing, which involves buying fixed volumes of debt. Or Japan-style yield-curve control, which means purchasing whatever amounts are needed to pin a chosen rate at a target level.
Fed officials are converging around forward guidance and asset purchases while they consider further questions about yield curve control. They are intent on keeping both short- and longer-term rates low, and are likely to provide strong signals to the market as their framework review concludes.
“I fear when we get back from Labor Day and get jobs data and retail sales, it could cast doubt on the recovery,” said James Knightley, chief international economist at ING Financial Markets. “That’s when you’ll start to hear the Fed step up more and talk about YCC and QE.”
This article was provided by Bloomberg News.