Taming an unpredictable yield curve
NEW YORK: The Treasury yield curve’s uphill sprint has faltered as investors contemplate just how the Federal Reserve might want to check its progress.
Investors are wading into the central bank’s debate over a possible return to the 1940s-era policy of yield-curve control to cap borrowing costs as the economy recovers.
Most expect a low-yield target for shorter maturities, potentially as soon as September. But there’s a case for focusing instead on the longer end in any subsequent step, according to Societe Generale.
And Blackrock Inc, for one, is sceptical that the Fed will go out on a limb with a specific level until more drastic action looks needed.
How the Fed proceeds is key for investors who have plowed into steepening bets, a move that peaked with last week’s surge in 10- and 30-year yields. Few expect the Fed to unveil anything definitive in its policy statement. But all are on the lookout for signs that officials have shifted their focus for Treasuries from market repair amid the pandemic to a longer-term strategy.
“Having that yield-curve control or very supportive forward guidance is a critical component for investors,” said Hamish Pepper, a fixed-income and currency strategist at Harbour Asset Management in Wellington, New Zealand.
“Markets need more than just the promise of buying whatever it takes.”
Fed chair Jerome Powell is likely to field questions about how, or whether, the central bank could put a ceiling on yields as the government unleashes spending to avert a lengthy recession.
Ten-year Treasury yields, a benchmark for global borrowing, touched 0.96% last week, the highest since mid-march, before falling to just above 0.8% as the rally in stocks lost steam. Yields on the long bond have dipped back after reaching the highest since 2016 relative to five-year rates.
Different versions of curve control appear to be in play: The Reserve Bank of Australia pinned its three-year yield at 0.25% in March, while the Bank of Japan has tethered the 10-year around zero since 2016.
India’s central bank is taking less explicit steps to contain long-end yields, analysts say, with asset-purchases similar to the Fed’s Operation Twist.
The strategy of targeting the short end is seen as the likeliest approach for the United States, in part because it’s the easiest segment of the curve for the Fed to control. It would also send a strong signal that the Fed intends to keep short rates low.
In Australia, the three to 10-year curve has steepened almost 20 basis points this month, which should draw buyers to the longer maturity.
“The safest trade you can come up with is to buy five- to six-year bonds,” said Chris Rands, a money manager at Nikko Asset Management Ltd. in Sydney.
“In two years’ time, you’ll have a three-year bond and the RBA could be pinning it to 0.25%.” How this strategy would translate to the United States is another question.