The Fed shouldn’t try to ‘control’ interest rates

A cyclist passes by the headquarters of the Federal Reserve in Washington.

Kevin Lamarque | Reuters

A little unsolicited advice for the Federal Reserve…don’t be a control freak.

While it’s usually the Fed’s job to attempt to exert control over all aspects of credit market behavior, it may want to stop before taking one more step that has presented itself as a possibility. real: capping the yield curve.

“Yield curve control,” a move the Fed is reportedly considering, would cap both short- and long-term interest rates to ensure low rates continue to stimulate the economy at less or up to that it accelerates towards its long term. execution potential and inflation also begins to rebound.

The recent rise in interest rates, particularly the 10-year yield, reflects the market’s belief that the reopening of the economy could go more smoothly and heat up faster than anyone thought possible a while ago. only a few weeks.

It also poses a bit of a problem for the nascent economic recovery.

To the extent that bond market prices experience not just a faster rebound but additional fiscal and monetary stimulus, the more deflationary pressures dissipate, rates are bound to rise.

This would dictate, under typical circumstances, that the yield curve steepens appropriately.

However, not everyone thinks that the combination of faster growth and larger deficits, already likely to top $4 trillion this year alone, will generate above-trend growth, a pick-up in inflation and a class of investors unwilling to finance debt and deficits.

This means that the cost of running a tab will increase, especially as the government’s debt offerings get bigger and bigger.

Controlling the yield curve would or could negate the possibility of a bond market rebellion by keeping rates low, allowing consumers, businesses and governments to continue to have access to easy money and to give the government extra time to fund relief and stimulus legislation, without the wait. soaring borrowing costs.

Typically, I have favored such programs as a result of clear and present dangers to the economy. I have certainly supported the swift and powerful efforts made to date, given the nature of the recent and rapid collapse in national and global economic activity.

One step too far

That said, a lot has been done so far: $3 trillion in relief efforts and a huge expansion of the Fed’s balance sheet with more likely to come.

In some cases, such as providing assistance to state and local governments and extending unemployment insurance to those who have suffered permanent layoffs, the measures are necessary steps to ensure recovery.

Controlling the yield curve, even as the Fed engages in quantitative easing, extends credit to small and large businesses and, in my view, may be a step too far to take.

The Fed capped yields in the aftermath of the Great Financial Crisis as the central bank and federal government recapitalized the banking system and aggressively fought entrenched global deflation.

Manipulating the yield curve was the right move then, as banks were in dire need of liquidity and needed a lot of help to stay solvent, before worrying about making money from widening spreads.

The financial system simply does not need this kind of help right now.

Indeed, a steepening yield curve actually helps the banking system stay profitable and well capitalized while Main Street begins to recover.

A different slowdown

Perhaps more importantly, this time around, curve control may deprive the Fed of a key market message that can tell the Fed and the feds when enough relief and recovery, lending and expenses, have gone quite far.

The yield curve is a powerful economic signal that can predict a recession and a recovery. The circumstances and nature of this economic disruption are very different from the previous one and require many of the same tools to fight the recession of yesterday and today.

But, another financial crackdown in what could be the shortest recession/recovery cycle in history suggests the Fed needs all the feedback mechanisms it can find, even if it means risking a manageable rise in prices. short-term and long-term interest rates.

The Fed has made it clear that it will do everything in its power to ensure a full recovery. He may have done whatever was required of monetary policy. The yield curve will confirm or disprove this notion in these unusual circumstances.

While I’m clearly not a central banker, I would be reluctant to cut a key market contribution that could help make the difference between keeping the economy too cold, helping until it’s too hot, or doing well things. We would all like to see a return of the Goldilocks economy.

But controlling the yield curve could ultimately be a wolf in bull’s clothing.

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