FOMC minutes show little support for yield curve control

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Expectations of the use of yield curve control may have been dashed by the minutes of the Federal Open Market Committee’s July meeting.

“Most judged that yield caps and targets would likely provide only modest benefits in the current environment, as the Committee's forward guidance regarding the path of the federal funds rate already appeared highly credible and longer-term interest rates were already low,” the minutes said.

Also of concern was “potential costs associated with yield caps and targets," including "an excessively rapid expansion of the balance sheet and difficulties in the design and communication of the conditions under which such a policy would be terminated, especially in conjunction with forward guidance regarding the policy rate."

Despite the reluctance to use yield curve control now, the minutes say, they "should remain an option that the Committee could reassess in the future if circumstances changed markedly.”

While not ruling YCC out forever, Marvin Loh, senior global macro strategist at State Street, said it appears the balance sheet expansion was the panel's biggest concern. “Overall, the minutes don’t contain many surprises," he added. "Other than YCC, most of the expected policy changes are still on the calendar. The Fed is worried about the pace of the recovery, however, more than it was in June, and likely more worried given the stalemate on fiscal stimulus in Washington. The Fed will continue to do what it can, but it does feel that fiscal is as important in the recovery process as monetary, and their tools to get funds to Main Street remain constrained.”

The panel also noted the “very elevated” uncertainty about the economic outlook, as it depends on how the coronavirus progresses and "the public sector’s response to it."

This uncertainty led "several participants" to suggest “additional accommodation” may be needed to push recovery and return inflation to the Fed’s 2% target.

Among the “several” risks to the outlook, the panel noted, future outbreaks that cause “extended economic disruptions” and “a protracted period of reduced economic activity.”

Participants still believe it is “appropriate to maintain” the near-zero federal funds rate target until they are "confident that the economy had weathered recent events and was on track to achieve the committee’s maximum employment and price stability goals.”

Lon Erickson, portfolio manager and managing director at Thornburg Investment Management, said "the Fed is terrified by the total darkness COVID is casting over the economic outlook" and will keep rates low and liquidity "plentiful for a long time. Extra money in the economy helps, but it’s not a vaccine.”

“If the FOMC is ‘not even thinking about thinking about raising rates,’ then what are they considering? Are they contemplating increasing their inflation target to above 2%? It appears they are,” said Sam Dunlap, CIO of public strategies at Angel Oak Capital Advisors.

The minutes noted a discussion of potential changes to longer-run goals and monetary policy strategy.

“Participants agreed that, in light of fundamental changes in the economy over the past decade — including generally lower levels of interest rates and persistent disinflationary pressures in the United States and abroad — and given what has been learned during the monetary policy framework review, refining the statement could be helpful in increasing the transparency and accountability of monetary policy,” Dunlap said.

Erickson said he does not believe the Fed will use negative rates, as Chair Jerome Powell “gave the Heisman” to a reporter who asked about it at his latest press conference.

And while the minutes seem to rule out yield curve control at this time, Erickson said, “I think the Fed is more likely to enact curve control if needed to keep long rates from hurting parts of the economy, most notably housing. Thus far the market has done the job for them, keeping the 10-year in a fairly tight range, but of course, the market could always drive rates into negative territory on its own.”

Participants agreed the Fed should "increase its holdings of Treasury securities and agency residential mortgage-backed securities (RMBS) and CMBS at least at the current pace."

“The Fed cannot overcome the impact of COVID on the economy alone,” Erickson said. “It needs the federal government to pass another stimulus package as the Fed has lifted the animal spirits in the financial markets, but it’ll take fiscal stimulus to keep the animal spirits stirring in the real economy.”

The panel also voiced concern about financial stability. “Banks and other financial institutions could come under significant stress, particularly if one of the more adverse scenarios regarding the spread of the virus and its effects on economic activity was realized,” the minutes said.

“There was also agreement that providing stronger forward guidance was appropriate once their policy changes are announced,” Loh said. “This may take the form of outcome based, or time specific. Tying it to an inflation and/or unemployment rate is the more likely result; again this could correspond with a September or November announcement.”

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