Fed Not Looking to Cap Short Term Yields, At Least For Now

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The Federal Reserve is unlikely to cap short-term yields as part of its economic stimulus measure for now.

The Federal Reserve is unlikely to cap short-term yields as part of its economic stimulus measure for now, according to the Wall Street Journal.

The central bank may use that option later. At the June rate-setting meeting, Fed officials were given details about the use of yield caps in Japan and Australia. The Fed has deployed this option before, between 1942 and 1951. The Fed is expected to release the minutes from that meeting tomorrow.

Fed officials haven't come to a conclusion regarding placing a cap on short-term Treasurys. They are more focused on forward guidance and the bond-buying plan, the foundation of the stimulus plan.

Yield caps involve the Fed buying Treasury securities to keep yields at low levels. For example, if the Fed determines that the US economy needs rates near zero for at least three years before meeting goals to keep inflation near 2 percent and unemployment low, capping yields on every security that matures before June 2023 would help strengthen this plan.

Wall Street has been watching the Fed closely to determine the effects of yield caps. Many are expecting some type of yield cap strategy by early September.

Some central bank officials have indicated that they would prefer laying out forward guidance and asset-purchase plans.

“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 said. 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 believes the yield cap strategy would interfere 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 stated “if we have very robust forward guidance,” the Fed will be able to keep rates low and stable across the yield curve “without having to go to yield curve control.” "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 believe yield caps are needed because investors are expecting the Fed to keep rates low for the foreseeable future. “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 recently said.

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