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Investors rethink yield curve control horizon as Fed raises doubts

NEW YORK (Reuters) – Investors are dialing back expectations that the U.S. Federal Reserve may soon move to implement yield curve control, with some of them welcoming skepticism from the central bank in considering such a move.

Federal Reserve minutes released on Wednesday showed serious questions were raised about the strategy. Some bond market players had become increasingly convinced that one of the Fed’s next moves would be to cap yields at a specific point on the curve, by buying 2- or 3-year maturities for example.

“The simple reason the Fed will be skeptical is that you are asking a central bank to embark on a very risky change in policy, and it’s not clear that where it has been attempted, it actually works,” said Andrew Sheets, chief cross-asset strategist at Morgan Stanley.

The Fed’s discussion has centered on whether to import the sort of long-term interest rate targeting currently used by the Bank of Japan (BOJ) and the Reserve Bank of Australia (RBA).

Various Fed members have talked about yield curve control the past couple of months. In May, Fed Vice Chair Richard Clarida and New York Federal Reserve Bank President John Williams said yield curve control could be a tool to complement forward guidance.

Yields on two-year, three-year, five-year and seven-year issues have fallen since the March stock market sell-off and since Fed officials started talking about yield curve control.

For a graphic on Yield control by stealth:

here

“I think there was a subset of market participants that saw (yield curve control) by September as a foregone conclusion,” said John Roberts at NatWest Markets, who added that the front-end of the U.S. Treasury curve “cheapened a bit following the release of the minutes, so it’s possible some were unwinding YCC trades”.

Analysts at Goldman Sachs said in a research note Wednesday that they no longer expect yield curve control to be introduced at the Fed’s September meeting, although they still expect the committee to recognize the policy as an option for the future in its framework review.

Fed officials did appear to favor crafting some promises about the future – in effect making a pledge not to raise rates until some goal is met.

“What they made very clear is (yield curve control) is not their first tool of choice, it is ahead of negative interest rates but behind explicit outcome-based forward guidance,” said Jason Ware, chief investment officer at Albion Financial Group.

Controlling bond yields by purchasing certain maturities of U.S. Treasuries would keep yields where the Fed desires and help keep credit and business lending rates low.

The expectation for yield curve control has come as the U.S. Treasury has greatly increased borrowing. It announced in May plans to borrow nearly $3 trillion in the second quarter, more than five times larger than the previous record, while the July-September quarter would see borrowing of $677 billion.

For a graphic on Monthly U.S. Treasury issuance by tenor:

here

Marvin Loh, senior global macro strategist at State Street Global Markets in Boston, said he would take yield curve control “off my plate for 2020 unless we really see yields rise,” adding that if yields in the 3-7-year part of the curve were to get “out of control, particularly given how much issuance the U.S. Treasury has been doing, then the market would wind up more concerned.”

Still, the focus on yield curve control has “basically meant that the Fed has already accidentally implemented it,” said Jon Hill, U.S. rates strategist at BMO Capital Markets, citing five-years yields hitting all-time lows on Tuesday.

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Fed's Powell continued to talk frequently with Mnuchin, lawmakers in May

WASHINGTON (Reuters) – Federal Reserve Chair Jerome Powell continued to talk regularly with Treasury Secretary Steven Mnuchin and key U.S. lawmakers in May as the United States began to turn the corner on the economic fallout from the coronavirus pandemic, Fed records released on Thursday showed.

Powell and Mnuchin conducted 16 phone calls during the month, down from 21 in April, the readout of Powell’s calendar indicated, but still well above their usual frequency before the health crisis began to pummel the economy.

In addition, Powell held 20 calls with key U.S. lawmakers, six more than in April. The central bank chief appeared before the Senate Banking Committee in mid May as part of its oversight of how the Fed has handled implementing emergency support programs authorized by the CARES Act.

In coordination with the Treasury, the Fed has rolled out nearly a dozen programs to keep credit flowing to businesses and households.

More unusually, Powell spoke in May with the head of Turkey’s central bank as fallout from the pandemic was putting enormous pressure on the Middle Eastern country’s economy, and its currency.

Larry Fink, chief executive of BlackRock Inc (BLK.N), the world’s largest asset management company, spoke with Powell for the third consecutive month, the calendar also showed. The Fed has hired Blackrock to advise on some of its emergency facilities.

Despite his busy schedule, which stretched into some weekends, Powell also found a window of time for more glamorous pursuits, posing for TIME Magazine on May 13.

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Fed's Bullard warns of financial crisis risks as virus cases spike: FT

(Reuters) – St. Louis Federal Reserve Bank president James Bullard has warned that a growing number of bankruptcies due to the coronavirus outbreak could lead to a financial crisis, the Financial Times reported.

“Without more granular risk management on the part of the health policy, we could get a wave of substantial bankruptcies and (that) could feed into a financial crisis,” Bullard said in an interview with the newspaper on Wednesday. (on.ft.com/31AlcUF)

He warned of “twists and turns” in the health crisis and said “it’s probably prudent to keep our lending facilities in place for now, even though it’s true that liquidity has improved dramatically in financial markets.”

New U.S. COVID-19 cases rose by nearly 50,000 on Wednesday, according to a Reuters tally, marking the biggest one-day spike since the start of the pandemic. The surge in cases across the country, including the populous states of California, Florida and Texas, threaten the budding recovery.

Bullard said that it is possible that the country could “take a turn for the worse at some point in the future”, but added that it was not his base case, according to the report.

The Fed moved aggressively in March to support the U.S. economy by cutting rates to near zero, buying up trillions of dollars in bonds and launching a slate of emergency lending tools to keep credit flowing to households and businesses.

The last of those programs was launched on Monday, which the Fed can use to buy newly minted corporate bonds.

“With all these programmes, the idea is to make sure the markets don’t freeze up entirely, because that’s what gets you into a financial crisis, when traders won’t trade the asset at any price,” Bullard added.

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Fed deluged by letters from needy over its loan program

(Reuters) – The U.S. Federal Reserve on Wednesday released thousands of letters and emails from individuals, businesses and nonprofit groups this spring urging the central bank to widen access to its Main Street Lending Program to more entities struggling to survive the coronavirus-triggered recession.

The writers included school-meal providers, the American Hospital Association, a tuxedo rental company, the U.S. Olympic & Paralympic Committee, local YMCAs and the California State University system. Pleas for help also came from energy providers, Dallas hotel magnate Monty Bennett, and advocates for the needs of felons.

The Fed launched it Main Street lending program in mid-June to help small and mid-sized businesses hurt by the recession which need funds to tide them over until the economy recovers.

Despite the yawning need evidenced in the letters, the program as of last week had not yet made a single loan. So far 300 lenders have signed up to participate, Fed Chair Jerome Powell said this week.

The correspondence, which the Fed had acknowledged previously, sketch the depth and breadth of the need created by the coronavirus crisis across the United States.

It paints a picture of a central bank, which once closely guarded its secrets, newly open to public feedback and willing to respond by reshaping its policies. Many groups pleaded with the Fed to allow nonprofits access to the program. Others asked for reduced minimum loans and otherwise a lower bar for borrowing.

After receiving the letters the Fed tweaked its program to meet many of those demands, and released a proposal to allow nonprofits to borrow alongside private companies.

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Fed revisits idea of pledging to keep interest rates low

WASHINGTON (Reuters) – Federal Reserve policymakers are looking at reviving a Great Recession-era promise to keep interest rates low until certain conditions are met, in a bid to deliver a more rapid recovery from the recession triggered by the coronavirus pandemic.

The policymakers “generally indicated support” for tying rate-setting policy to specific economic outcomes, minutes from the U.S. central bank’s June 9-10 policy meeting showed on Wednesday. “A number” favored a promise to leave rates low until inflation meets or even modestly exceeds the Fed’s 2% goal.

A couple of policymakers preferred tying changes to rates to a specific unemployment rate; a “few others” wanted to promise easy monetary policy until a specific date in the future – an approach the Fed used effectively in 2012 and 2013.

Although two warned of the danger of adopting any such policy, citing financial stability risks, the minutes showed that policymakers overall supported giving the public more explicit forward guidance, both for rates and bond purchases, “as more information about the trajectory of the economy becomes available.”

The readout showed much less support, and many questions, about alternate forms of support including control of the yield curve, a strategy in use by other central banks around the world.

Fed officials anticipate the United States will suffer the worst economic downturn since World War Two, and they have no intent to let up on providing stimulus for the foreseeable future.

“Members noted that they expected to maintain this target range until they were confident that the economy had weathered recent events and was on track to achieve the (rate-setting) Committee’s maximum-employment and price-stability goals,” the Fed said in the minutes.

The U.S. dollar slightly extended losses against the yen and euro while the S&P 500 index edged higher after the release of the minutes.

OUTLOOK UNCERTAIN

The Fed has repeatedly said the U.S. economic outlook remains highly uncertain and reiterated that a full economic recovery hinges on the battle to control the spread of the novel coronavirus, which has killed more than 127,000 people in the United States.

Since the meeting, a surge in U.S. infections has led several policymakers to warn that signs of a nascent economic recovery over the last few weeks could already be under threat as hard-hit states halt or reverse the re-opening of their economies.

The U.S. economy slipped into recession in February and economic output and employment are still far below pre-crisis levels despite a rebound as restrictions were eased. More than 30 million people were receiving unemployment checks in the first week of June, about a fifth of the labor force.

Related Coverage

  • Fed mulls promises for the future, appears to discount yield curve control
  • Fed deluged by letters from needy over its loan program

At last month’s policy meeting, the Fed signaled it planned years of extraordinary support for the economy, with policymakers projecting the economy to shrink 6.5% in 2020 and the unemployment rate to be 9.3% at the end of the year.

In addition to slashing interest rates, the central bank has also pumped trillions of dollars into the economy to keep credit flowing to businesses and households.

Americans’ anxieties over the spread of the coronavirus are at the highest level in more than a month, a Reuters/Ipsos poll showed on Wednesday, a day after the United States recorded the biggest single-day rise in new cases since the pandemic began.

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Fed's Daly sees 4-5 year recovery in best-case scenario

(Reuters) – San Francisco Federal Reserve Bank President Mary Daly on Wednesday painted a grim picture of the U.S. economic outlook, saying that even under her best-case scenario unemployment will still top 10% at year’s end and won’t return to pre-crisis levels for four or five years.

“If we can get the public health issues under control either through a really robust mitigation strategy or a vaccine, then we can reengage in economic activity really quickly,” Daly told Washington Post Live in a virtual program. “Then it could take just four years or five years; but if we end up with a pervasive long-lasting hit to the economy, then it could take longer.”

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Fed's offered flood of credit so far just a trickle in practice

(Reuters) – The Federal Reserve’s promise in the early days of the coronavirus pandemic to flood the U.S. economy with trillions of dollars seemed like the proverbial central bank bazooka.

It has been more of a trickle in practice, with activity outside the U.S. Treasury and other core financial markets so far only a fraction of what’s available, and with lending to companies in the “real” economy virtually nonexistent.

When Fed chair Jerome Powell appears before the House Financial Services Committee on Tuesday to discuss the central bank’s crisis response he will likely be pressed on that: More than three months into the worst economic meltdown since the Great Depression the Fed so far has made no loans under a vaunted “Main Street” program for small and medium sized companies, provided only $1.2 billion to local governments, and holds just $8.3 billion in corporate bonds.

It may, as Fed officials contend, be overall good news, and evidence their mere announcement of support for the economy has kept private lenders and borrowers transacting on their own, kept financial markets stable, and lifted confidence the Fed could keep the worst from happening.

Still, analysts including former Fed chair Ben Bernanke have questioned whether the Fed has been too strict in setting up its programs. While many worked as intended, the fact no Main Street loans have been issued “is a concern both politically and also in terms of getting liquidity to the firms that need it,” Bernanke said last week in a Brookings Institution webinar.

Bernanke said the Fed may need to make its laboriously designed Main Street program “more generous,” with lower costs for borrowers or subsidies for banks initiating the loans, if it wants to keep otherwise healthy small and medium businesses from ruin in the crisis.

“What we need is a compromise where we assist short term survival for small firms while not creating zombie firms,” that survive on cheap credit alone, Bernanke said. “It is not clear that the Main Street program … is going to be enough.”

LITTLE UPTAKE

So far none of the programs set up to backstop companies and markets outside the financial sector have seen much use. By contrast more traditional programs to ensure financial institutions keep doing business in a crisis have been more extensive and by most accounts successful.

Since late February the central bank has increased its overall balance sheet – a measure of its footprint in the economy – from $4.2 trillion to $7.1 trillion.

Most of that stemmed from keeping the government bond and mortgage-backed securities markets on track: holdings of U.S. Treasuries and MBS increased around $2.4 trillion. Foreign central banks swapping their currencies for dollars accounted for another roughly $230 billion.

What distinguished the response to this crisis from the 2007 to 2009 financial meltdown was the offer to lend directly to private firms and local governments. Announced with fanfare in early April, the Fed said it would, among other steps, provide around $2 trillion to buy bonds to finance large corporations; lend directly to small and medium sized businesses; and help state and local governments raise funds to meet expenses.

Weeks later those programs are up and running – the Fed on Monday launched its latest effort to purchase new corporate bond issues – but of the $1.85 trillion notionally available only about $9.5 billion has been tapped.

The Fed of course can’t make people apply for loans, and the credit costs and other measures that might trigger more aggressive purchases of corporate bonds, for example, have improved since the early days of the pandemic.

Powell in prepared remarks for Tuesday’s hearing said Main Street lending may prove valuable “in the months ahead” for firms hit by the dramatic drop in economic activity during the pandemic.

Still, analysts are cutting estimates of how large the Fed’s balance sheet might grow during a crisis some thought might test its capacities.

The CARES Act raised the possibility of $4.5 trillion in credit flowing from the central bank. The total may end up less than a fourth of that.

“The usage of the Fed credit facilities has been much slower and smaller than we had anticipated,” Oxford Economics analyst Kathy Bostjancic wrote last week, estimating perhaps only half of the Main Street loans available will be taken and perhaps less than a third of the corporate bond fund be used.

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Big tobacco, big oil and Buffett join Fed's portfolio

WASHINGTON (Reuters) – The U.S. Federal Reserve bought $428 million in bonds of individual companies through mid-June, making investments in household names like Walmart and AT&T as well as in major oil firms, tobacco giant Philip Morris International Inc, and a utility subsidiary of billionaire Warren Buffett’s Berkshire Hathaway holding company.

The transactions disclosed Sunday are the first individual company bond purchases made by the Fed under new programs set up to nurse the economy through the coronavirus pandemic. The Fed also added $5.3 billion in 16 corporate bond exchange traded funds, including a newly added sixth high yield fund.

The initial round of purchases included some 86 issuers, about half of them contractually settled as of June 18 and some still underway, all bought on the secondary market.

That is a small slice of the more than 790 issuers whose bonds the Fed has said in a separate release were eligible for purchase.

But it was still a first foray into corporate bond purchases that spread broadly across the economy, touching firms like Gilead Sciences that are involved in developing treatments for the COVID-19 disease caused by the novel coronavirus, as well as major automakers. That included Ford Motor Co., whose credit was downgraded to junk status after the Fed announced its intent to buy corporate debt.

Both the Bank of Japan and the European Central Bank have programs to buy individual corporate bonds, but the Fed only added that to its arsenal in light of the Depression level risks posed by the pandemic. The aim is to ensure companies can continue to finance themselves, and not be forced out of business due to problems raising cash during a pandemic. The program is backed by investment capital from the U.S. Treasury to absorb any losses should corporations default.

The largest purchases were of bonds issued by AT&T and the United Health Group, with the Fed buying around $16.4 million of bonds from each.

Issuers in the energy industry accounted for about 8.45% of the bonds purchased, about a percentage point less than their representation in a broad market index that the Fed says its purchases are intended to track over time.

The Fed’s bond purchases and other emergency programs will be scrutinized by lawmakers at a Tuesday hearing before the House Financial Services committee with Fed chair Jerome Powell. Questions may focus on the individual bonds purchased, but also on the fact that support for the bond markets used by major firms is now up and running and getting billions of Fed support, while the Fed’s Main Street Lending Program for smaller companies has yet to make a loan.

The central bank’s programs overall have so far seen modest use. The central bank’s overall balance sheet has declined for the past two weeks, falling to $7.08 trillion more recently as foreign governments made less use of Fed dollar swap lines.

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