Stretch It
The Fed’s commitment to keeping its policy rate low for years has left yields with maturities out to five years around or even below the top of its target range for overnight loans. For many strategists, that means the Fed needs to buy long-term debt to have any fresh impact on the economy.
The same holds true if business activity keeps rebounding. In that case, the bet is that Powell would prevent long-term rates from spiking up and crimping the recovery.
“The Fed is very comfortable with having a tremendous footprint in the bond market,” said Ralph Axel, a strategist at Bank of America Corp. “They will want to keep long-term rates low in a good economy as well as in a very bad one.”
The Fed currently is not actively managing the duration of its debt purchases, but is buying a range to roughly match the maturity composition of Treasuries outstanding.
The biggest chunk of its purchases since mid-March have been in maturities up to 2.25 years, with about 33% in that bucket, according to Bloomberg Intelligence’s Angelo Manolatos and Ira Jersey. The second-largest share -- about 21% -- is in the 2.25- to 4.5-year sector.
“The market is focused for the near term on more QE coming from the Fed, which may put additional flattening pressure on the yield curve,” said Guneet Dhingra, a strategist at Morgan Stanley. “The low-hanging fruit for the Fed would be to increase the amount of Treasury purchases. They could also extend the duration of their purchases -- which would give even more support to economic conditions.”
Meanwhile the tool of yield-curve targets, touted by some policy makers in the past as a way to cap yields, has been sidelined for now in a debate over costs and benefits.
Higher yields may seem like a far-off prospect. But the Fed may be eager to keep a lid on them to avoid a sell-off similar to the so-called taper tantrum of 2013, strategists at Societe Generale say. In that episode, the mere suggestion by then-Chairman Ben Bernanke that the Fed could scale back debt purchases wreaked havoc in long-term rates.
“The Fed clearly doesn’t want to live through what happened to markets during the taper tantrum,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. “It may in coming weeks increase the amount of Treasuries it’s buying as a way to ensure yields remain low.”
This article was provided by Bloomberg News.