By Karen Brettell
(Reuters) – The prospect of ballooning U.S. Treasury debt issuance, on the back of the government actions to counter the economic pain of the coronavirus, has investors asking whether the Fed will deploy a tool that has not been used in over 70 years – yield curve control.
Yields jumped this week even as stock markets fell as investors rushed to sell assets, including Treasuries, and raise cash. Another negative for bonds would be the jump in new paper that must be sold to finance fiscal stimulus in the scramble to offset the economic hit from business shutdowns as the coronavirus spreads.
U.S. Treasury Secretary Steven Mnuchin on Thursday urged Congress to move quickly to pass a $1 trillion economic relief measure by early next week. He added that the federal government was focused on being able to provide liquidity to companies and had no problem issuing more debt, but that it expected loans to businesses to be repaid.
With yield curve controls, the Fed can limit yield increases by buying as many bonds as necessary when yields rise over a certain rate to take yields down to its target.
This differs from the quantitative easing that central banks have deployed since the 2008 financial crisis, which involves buying targeted quantities of fixed-income assets like Treasuries and mortgage-backed securities, but cannot guarantee that yields stay low.
“When yields got so low it was like, ‘What’s the point?’ Now that yields have backed up somewhat, I would think that (yield curve control) is more in play, though the absolute level for yields isn’t that high,” said Eric Stein, co-director of global income at Eaton (NYSE:) Vance Management in Boston.
“I don’t think the Fed will allow medium-term real rates to rise in an environment where real growth prospects aren’t very high,” he added.
Benchmark 10-year Treasury yields () have risen to 1.12% after hitting a record low of 0.318% on March 9. They are still below the 1.91% level from year-end, though yields then reflected more optimism on the economy before the virus spread globally.
Higher Treasury yields caused by a dramatic uptick in supply, making it more expensive for companies and consumers to borrow, would counter efforts by the government and the U.S. central bank to simulate growth.
The jump in yields this week also runs counter to falling inflation expectations as oil prices plunge, adding an additional headwind to the Fed’s attempts to hit a 2% inflation target.
“That’s the paradox right now,” said Jim Caron, senior global fixed income portfolio manager at Morgan Stanley (NYSE:) Investment Management in New York.
“So how does this get rectified? Probably we go into the central bank tool kit and you exercise some type of yield curve control,” he said. “If they institute some type of yield curve control or start to talk about it, yields are going to drop a lot.”
Fed officials, including Governor Lael Brainard, have discussed yield caps as an option in the next downturn.
“The downturn is here and if the bond sell-off persists… interest-rate-sensitive industries like U.S. housing could suffer so… such action might make good policy sense at this juncture,” Citigroup (NYSE:) interest rate strategists said this week in a report.
The Fed this month slashed rates to zero, launched a new bond purchase program and instituted several operations meant to help liquidity in markets, though problems with Treasury liquidity have been ongoing.
The Fed has once before adopted yield curve caps to assist the Treasury in financing the cost of World War Two. The Bank of Japan introduced yield curve control in 2016.
The United States is already facing higher debt needs as the deficit worsens and Social Security and health care costs rise due to an aging population. The non-partisan Congressional Budget Office, prior to the current crisis, expected U.S. federal debt held by the public to grow to $31.4 trillion by 2030, from $17.9 trillion this year.
Tax reforms made by the Trump administration in 2017 have added to rising debt needs. Bloomberg News reported on Thursday that the government is revisiting the option of issuing ultra-long bonds to finance the new spending.
“The cost coming out of this is going to astronomical and it’s going to be financed through the bond market and that’s why it is selling off. The safe-haven market has lost its ability to be a safe haven because it’s going to be the place we’re going to fund the post-crisis era,” said Jim Bianco, president of Bianco Research in Chicago.