By Nick Timiraos
The Federal Reserve is unlikely to cap short-term Treasury yields as part of its initial package of economic stimulus measures, instead reserving the option to cap yields later.
Fed officials were briefed at their June rate-setting meeting on the use of yield caps in Japan and Australia, and on the central bank's experience with yield caps between 1942 and 1951, according to recent interviews and officials' public statements. The Fed is set to release the minutes of that meeting Wednesday.
Officials haven't reached a consensus about when or whether to cap yields on short-term Treasurys. Some officials, including Fed Vice Chairman Richard Clarida and governor Lael Brainard, have approvingly cited the strategy as a meaningful way to reinforce their so-called forward guidance about how long they plan to keep rates near zero and purchase Treasury securities to stimulate the economy.
Fed leaders are focused for now on deciding how to detail their forward guidance and bond-buying plans, the main pillars of their forthcoming stimulus package. They are likely to continue those discussions at their July 28-29 policy meeting, with an eye toward announcing their plans as soon as September. The deliberations are fluid because of extreme uncertainty surrounding the paths of the virus and the economy.
Yield caps would reinforce low-rate pledges by committing to buy Treasury securities in whatever amounts are needed to peg certain yields at low levels. For example, if the Fed concluded that the economy would need rates near zero for at least three years before meeting its goals to keep inflation around 2% and to return unemployment to its prepandemic lows, it could strengthen this commitment by capping yields on every Treasury security that matures before June 2023.
The prospect that the central bank will cap yields on two- or three-year Treasury securities has received heavy attention from investors and Wall Street analysts in recent weeks, with several banks expecting some type of yield-cap strategy as soon as September.
Several central bank officials have indicated a strong preference toward first ironing out their forward guidance and asset-purchase plans. The Fed is much more familiar with those tools, and many officials haven't spent as much time getting comfortable with how they would use yield caps, sometimes called yield curve control.
"Targeting forward guidance and quantities on the balance sheet would be the policies I would want to use before we go to yield curve control," San Francisco Fed President Mary Daly told reporters on June 15. If investors still grew skeptical of the Fed's plans to keep rates low, or if yields rose for other undesirable reasons, caps could later be applied as "a little helper," she said.
Dallas Fed President Robert Kaplan, also speaking on June 15, said he was worried such a strategy would interfere too much with how financial markets price assets. "I worry about going too far, in terms of distorting the pricing mechanism of the Treasury curve," he said. "I wouldn't rule it out, but right now Treasury yields are relatively muted."
Cleveland Fed President Loretta Mester echoed those reservations in public remarks a few days later. "If we have very robust forward guidance," the Fed can keep rates low and stable across the yield curve "without having to go to yield curve control," she said during a question-and-answer session broadcast online June 17. "I'm open to using it as a reinforcement to forward guidance, but I'd like to see more study of that."
Officials don't think caps are needed now because investors don't expect the Fed to lift short-term rates for several years. "It's something we're really just educating ourselves on at this point. It's not something we have at all decided to do," Fed Chairman Jerome Powell told lawmakers June 17.
Ms. Mester and St. Louis Fed President James Bullard are among those who said they want to better understand how the Fed would potentially exit from such a policy. The Fed last used yield caps during and after World War II, when the central bank forced a standoff with President Truman to end the debt-buying policy.
"The exit...was very difficult, so it kind of ended in tears," Mr. Bullard said in June 23 interview on Bloomberg Television. A yield-cap strategy right now raises "more questions than answers," he said.
(END) Dow Jones Newswires
June 30, 2020 11:17 ET (15:17 GMT)
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