The main event of the trading week is here as today, the FOMC Statement and the press conference to follow will create volatility on the world’s financial markets. Investors’ focus is on the plot projection (i.e., how the Fed sees the federal funds level in the next two years) and on any possible changes to its existing facilities to fight the coronavirus economic shock.
Yield Curve Control (YCC) by the Fed?
Rumors in the market indicate that the Fed will signal today that one of its objectives during the recession is to lock-down the yield curve. The problem so far has been that the FX market and the equity market (e.g., Nasdaq) experienced a V-shape recovery, and the fear is that the rates are starting to play catch up. What if the 10-Y bond yield recovers the same way the AUDUSD or Nasdaq did?
If we judge by what the Fed plans, one could argue that it has already intervened in locking down the long end of the yield curve – hence the divergence between the markets. Yet still investors are split as to what the Fed will signal – active efforts to control the yield curve, or a wait and see stance?
The image above offers a clearer view of how the yield curve is steepening and why the expectations that the Fed will intervene. If history is offering any guidance, a central bank cannot influence the long end of the yield curve – but it may try, though, the way Mario Draghi did during its time at the helm of the ECB.
It requires a massive financial effort and plenty of time to implement such a program. If anything, the Fed taught investors a valuable lesson, time and again – never underestimate the length it will go.
In the aftermath of the 2008 financial crisis, the Fed introduced quantitative easing – strongly criticized back then, a popular monetary policy tool today. It put together a $4 trillion financial package to fight the coronavirus economic shock, one of the largest in the world. In doing that, it went into areas many Fed watchers did not believe the Fed will ever go. Yet as this is an unprecedented crisis, investors would be better off if they do not exclude unprecedented measures.
Last time when the 5- and 30-year curves looked like above was in 2016. The Fed prepared to tighten the monetary policy – hence, the chart today explains (some) investors’ expectations.