Derby's Take: After Bond-Market Tumult, Some See Need for Stronger Fed Response
By Michael S. Derby
Some economists and market participants believe the Federal
Reserve needs to speak more directly to a bond market that has seen
yields surge amid uncertainty about the monetary policy
Treasury yields shot higher last week, and higher long-term
interest rates in theory could create unwanted headwinds to growth
as the economy recovers from the coronavirus pandemic.
Fed officials including New York Fed leader John Williams have
said that rising yields are consistent with what appears to be a
strong path of recovery and that they see no need for the central
bank to respond.
Rising yields are "driven by a more positive outlook for the
economy...and maybe, you know, a more stabilized view of inflation
versus where we were before," Richmond Fed leader Thomas Barkin
said last week. Separately, Atlanta Fed leader Raphael Bostic last
week said he isn't worried and that "I'm not expecting that we'll
need to respond in terms of our policy." Messrs. Williams, Barkin
and Bostic hold votes on the rate-setting Federal Open Market
Lots of market participants don't think that rhetoric will
continue to fly, and some believe this is the week for officials to
change their story. A number of Fed officials will make public
appearances this week, including Fed governor Lael Brainard and San
Francisco Fed leader Mary Daly on Tuesday, Chicago Fed leader
Charles Evans on Wednesday, and Fed Chairman Jerome Powell on
Thursday. All these officials have FOMC votes as well.
"We think Fed officials will change tactics and intervene
verbally," economists at Oxford Economics said in a note. "Most
likely they will emphatically affirm their patient and dovish
stance, which accords with their new policy framework."
"A repeat of last week's disorderly jump in yields would
threaten the economic recovery," the Oxford economists wrote,
adding: "Policy makers will need to walk a fine line between
calming impatient bond markets while not sounding too sanguine
about higher inflation risks."
That said, the challenge before the Fed is large. Understanding
what's going on in the market right now, and how it relates to
monetary policy, isn't settled, and some think it may not even be
driven by economic considerations.
On top of that, the Fed is being battle-tested on its new policy
regime. Last year, it adopted a new policy-making system that aims
for inflation to overshoot the official 2% target to make up for
times it has fallen short.
The problem for market participants is that the central bank has
deliberately left vague how much of an overshoot it would tolerate
before raising short-term rates. The Fed also has left vague what
it would take for it to pare back on its other leg of support: $120
billion a month in Treasury and mortgage bond buying.
Officials expect inflation to pick up for a time before easing
as the recovery speeds up this year. As market participants brace
for higher inflation, they are unsure how price dynamics will react
in an economy recovering from an unprecedented shock and under a
monetary policy regime some see as vague.
Robin Brooks, chief economist with the Institute of
International Finance, said the problem the Fed faces is that its
new rate guidance system targets short-term rates and doesn't
address longer-term yields, which is where the problem has
Mr. Brooks said the work the Fed will need to do to keep
long-term yields down and moving in an orderly fashion is
rhetorical. He said the Fed will need to talk down coming growth
data that could be strong. Officials can also directly state that
yields have risen too much and note they are monitoring the
situation, he said.
"I think between clarifying Q2 GDP and doing some verbal
intervention you can already achieve a lot," Mr. Brooks said.
Oxford Economics believes the next step for the Fed, if talking
doesn't work, would be to change the pattern of its bond buying
toward longer-dated bonds, in a bid to push down those yields.
But Wrightson ICAP economists are skeptical of such a strategy.
In a research note, the firm said the Fed has long anticipated
unruly bond-market action along the lines of the so-called taper
tantrum episode of 2013.
"Moving aggressively to flatten the curve now might just set the
stage for another tantrum down the road," Wrightson ICAP said. "And
that tantrum might be more extreme if the market has become more
dependent on long-duration Fed purchases." The firm expects the Fed
will try to navigate the situation by again explaining its new
policy-making system, all as part of an effort to play down any
sense that the timing of a Fed rate rise has moved forward.
Write to Michael S. Derby at firstname.lastname@example.org
(END) Dow Jones Newswires
March 02, 2021 05:44 ET (10:44 GMT)
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