- Bullard downplays chances of Fed yield-curve control policy
- 5-year T-note auction to yield near 0.34%
- U.S. home prices expected to rise in April but likely fall in coming months
Bullard downplays chances of Fed yield-curve control policy — Atlanta Fed President James Bullard on Tuesday made some useful comments regarding the odds that the Fed might adopt a yield-curve control policy. Analyst surveys indicate that the markets believe there is a fairly good chance that the Fed later this year might adopt a yield-curve control (YCC) policy, possibly targeting the 2-year or 5-year T-note yield level.
In a YCC policy, the central bank sets a target for a government bond yield level and then enforces that peg by buying government securities as necessary to make sure yields don’t rise above the target. A YCC policy is also referred to as interest rate cap policy.
The Bank of Japan has been using a YCC policy since 2016 and has successfully pegged the 10-year JGB yield at zero (with a range of +/- 0.20%). The Australian central bank in March just adopted a YCC policy by cutting its short-term policy rate to 0.25% and then setting a target for the 3-year Australian government bond yield of around 0.25%. The bank said the 3-year yield target will be achieved “through purchases of Government bonds in the secondary market.”
Mr. Bullard on Tuesday threw cold water on the idea that the Fed might adopt a YCC policy by saying, “Right now there are more questions than answers about this and I don’t really think it is a pending thing for the committee because we are already expecting rates to be low for quite a while.” Fed Chair Powell last week was noncommittal on a YCC policy and said that any discussion about a YCC policy was at an early phase and that no decisions had been made.
Mr. Bullard made the point that there is no need for interest rate caps at present since rates are expected to remain low for “quite a while.” The Fed-dot forecast is for the funds rate target to remain at its current level of 0.00%/0.25% through the end of its forecast horizon in 2022. Meanwhile, the 2-year T-note yield is currently trading at 0.19%, which is just 11 bp above the effective funds rate of 0.08%. The 10-year T-note yield is extraordinarily low at 0.71%.
There is no need for the Fed to announce caps on interest rates at this point since the market is already doing that by itself. If longer-term Treasury yields do start rising, then there would likely be a good reason for that rise in yields, such as a Covid-19 vaccine and expectations for the U.S. economy to return to normal within a matter of months. In that case, the Fed wouldn’t want to fight a rise in 10-year T-note yields.
With the stable interest rate situation seen at present, the Fed can afford to sit back and see how things develop regarding the pandemic and the economy. There is no immediate need for the Fed to take the rather drastic step of imposing interest rate caps.
In fact, the Fed might be asking for trouble by setting interest rate caps since the Fed would lose credibility if the markets were to break the caps, as markets are wont to do. As we mentioned yesterday, George Soros reportedly made a billion dollars busting the Bank of England’s sterling ERM peg in 1992 and the markets blew through the Swiss National Bank’s Swiss franc peg in 2015.
Mr. Bullard also made the point that exiting from a YCC policy can result in serious problems. He noted that the U.S. had a YCC policy during World War II “and after the war, the exit from the yield curve control was very difficult, so it kind of ended in tears. That is one of the main concerns about going in this direction.”
The bottom line is that the Fed seems unlikely to impose a YCC policy or interest rate caps as long as the economy continues to slowly recover and Treasury yields stay low.
5-year T-note auction to yield near 0.34% — The Treasury today will sell $20 billion of 2-year floating-rate notes and $47 billion of 5-year T-notes. The $47 billion size of today’s 5-year auction is up by $6 billion from the $41 billion size that prevailed during 2019 and early 2020 before pandemic expenses caused the federal government’s budget deficit to explode.
Today’s 5-year T-note issue was trading at 0.34% in when-issued trading late yesterday afternoon. The 12-auction averages for the 5-year are: 2.43 bid cover ratio, $26 million in non-competitive bids, 4.6 bp tail to the median yield, 24.8 bp tail to the low yield, 53% taken at the high yield, and 59.4% taken by indirect buyers (vs the median of 61.5% for all recent Treasury coupon auctions).
U.S. home prices expected to rise in April but likely fall in coming months — The consensus is for today’s April FHFA hose price index to show an increase of +0.3% m/m, adding to March’s increase of +0.1% m/m. Home prices are expected to rise in April because the supply of homes on the market was very tight, with very few people putting their homes on the market during the pandemic. Also, there has recently been strong demand for homes as seen by the fact that the MBA mortgage purchase sub-index has surged by +77% in the past nine weeks and has hit a new 11-1/2 year high.
While home prices are currently seeing support from strong demand and tight supply, conditions in the housing market are likely to shift soon. In fact, home prices are likely to start falling in coming months after mortgage forbearance programs expire and a deluge of foreclosed homes start to hit the market. More than 8% of all U.S. mortgages were past due or in foreclosure in May, according to property information service Black Knight Inc. That illustrates the scale of mortgage troubles and the potential overhang from foreclosures.
