Questions remain about yield curve control

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Observers expect the Federal Open Market Committee to consider implementing yield curve control as early as September, despite many questions about its efficacy, since it hasn't been used in the U.S. since just after World War II.

Japan has used yield curve control since September 2016, and, on the inflation front, it seems to be failing, according to Matthew Higgins and Thomas Klitgaard, vice presidents of the research and statistics group at the Federal Reserve Bank of New York.

"Core inflation [in Japan] has been running near 0.5% in recent months, barely higher than when the policy was adopted," according to Higgins and Klitgaard.

Federal Reserve Bank of New York
Federal Reserve Bank of New York

But, the policy has been successful by other metrics. "The yield target approach allowed for a dramatic scaling back in purchases. In Japan’s case, the commitment to purchase whatever was needed to keep the ten-year rate near zero has meant that very little in the way of asset purchases have been required."

Persistently low inflation is now the expectation in the island nation, and when yield curve control was implemented “long-term yields were already near zero,” the authors wrote in a recent report. “If monetary stimulus alone had the power to push Japanese inflation up to 2%, it likely would have happened already under [Quantitative and Qualitative Easing]." Additionally, they said, there's no way to "know what inflation would have been without YCC. It should also be noted that the unemployment rate before the COVID-19 outbreak was near historic lows, so there was the possibility that continued labor market tightness would have eventually pushed inflation higher.”

Before using YCC, the Fed would need to determine: "What rate is targeted? How much should rates be allowed to vary around the target? What guidance should be offered about the conditions under which the target rate and range might change? And, ultimately, does YCC help a central bank achieve its policy goals?"

The authors conclude while it's unclear if YCC helped japan achieve its goals, it has kept the Bank of japan from being forced to make asset purchases. "Investors accept that the Bank can buy whatever quantity of JGBs is needed to keep yields from rising and, as a result, it has not had to buy many at all.”

Home sales
Existing home sales fell 9.7% in May, to a seasonally adjusted 3.91 million annual rate, according to the National Association of Realtors. In April, sales dropped 17.8% to a 4.33 million annual pace.

Economists polled by IFR Markets expected a 4.10 million sales rate.

“Sales completed in May reflect contract signings in March and April — during the strictest times of the pandemic lockdown and hence the cyclical low point,” according to NAR chief economist Lawrence Yun. “Home sales will surely rise in the upcoming months with the economy reopening, and could even surpass one-year-ago figures in the second half of the year.”

Sales were 26.6% below the level of May 2019. All four regions registered lower sales than last month and the same month last year.

“New home construction needs to robustly ramp up in order to meet rising housing demand,” Yun added. “Otherwise, home prices will rise too fast and hinder first-time buyers, even at a time of record-low mortgage rates.”

Although the real estate industry faced some very challenging circumstances over the last several months, we’re seeing signs of improvement and growth, and I’m hopeful the worst is behind us,” NAR president Vince Malta said.

Chicago Fed national activity index
The Federal Reserve Bank of Chicago's national activity index rose to positive 2.61 in May, from a downwardly revised negative 17.89 in April, showing “economic growth increased substantially” in the month.

The April figure was orginally reported as negative 16.72.

The CFNAI-MA3 index, a three-month moving average, narrowed to negative 6.65 in May from a downwardly revised negative 7.50 in April, first reported as negative 7.22.

The CFNAI Diffusion Index, also a three-month moving average, gained to negative 0.43 in May, from a downwardly revised negative 0.58 in April, first reported as negative 0.55.

A reading of zero suggests the national economy is expanding at its historical average rate.

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Economic indicators Federal Reserve Bank of Chicago Housing Monetary policy Federal Reserve FOMC