Fed Brainard: yield curve caps when rates hit ELB
Rates
Core bonds traded with a small upward bias yesterday without clear driver. Risk sentiment on stock markets remained positive, but less outspoken. Mixed US eco data (including consumer confidence) didn't alter the intraday trading dynamics. The US $40bn 5-yr Note auction tailed slightly, but bidding metrics were strong. The German yield curve bull flattened with yields decreasing by 0.8 bps (2-yr) to 2.5 bps (30-yr). 10-yr yield spread changes vs Germany widened by up to 3 bps. US yields fell by 1.4 bps (10-yr) to 2.2 bps (30-yr).
Heavyweight Washington-based Fed governor Brainard offered her preliminary views on the Federal Reserve's review of its monetary policy strategy. She starts by admitting that she was struck that the effective lower bound (ELB) proved to be a severe impediment to the provision of policy accommodation initially because of long delays needed to develop consensus and take action on unconventional policy which sapped confidence, tightened financial conditions and weakened the recovery. For those reasons, she advocates a more mechanical approach for policy action when policy rates hit the ELB in future downturns. In particular, she sees advantages to an approach that caps interest rates on Treasury securities at the short-to-medium range of the maturity spectrum—yield curve caps—in tandem with forward guidance that conditions lift off from the ELB on employment and inflation outcomes.
Both would reinforce each other. In addition, once the targeted outcome is achieved, and the caps expire, any securities that were acquired under the program would roll off organically, unwinding the policy smoothly and predictably. The Fed's monetary policy review extends into 2020.
Most Asian stock markets extend gains this morning with China (-0.25%) underperforming. Chinese industrial profits fell by 9.9% in October, the most since at least 2011, with domestic demand slowing and producer prices falling. Core bonds tread water. Today's eco calendar contains US durable goods orders, weekly jobless claims, PCE deflators, Chicago PMI, income/spending data and new home sales. The probability that such complex of data triggers a directional move seems small. Ahead of the long weekend in the US, we expect core bonds to maintain their cautious upward bias.
Technically, the German 10-yr yield and US 10-yr yield both rebounded away from August lows following ECB/Fed September policy meetings. The German 10-yr yield broke above -0.41% resistance as geopolitical uncertainty diminished, improving the technical picture. Targets of this double bottom formation are -0.25% and -0.13%. The 38% retracement level of the Oct-Aug decline stands at -0.24%. The US 10-yr yield trades in the 1.43%-1.94% sideways trading channel. First tests to take out 1.94% failed, causing corrective return action lower.
Author
KBC Market Research Desk
KBC Bank
