US Federal Reserve Minutes Preview: It all about the bonds now

The Federal Reserve was the first American institution to respond forcefully to the economic implications of the pandemic when it cut the fed funds rate in early March. Events have given the governors credit for the prescience.

An innovative business and government loan program that soon followed has been little used. With the base rate at the zero bound the main tool of monetary policy has been the revival of quantitative easing through the purchase of $120 billion a month in Treasuries and asset-backed securities..

Bond purchases

The impact of the bond program is evident in the yield on the 10-year Treasury. On the last day of 2019 the 10-year Treasury yield was 1.919% and on February 5 it was 1.649%. A little over one month later on March 9 the same yield was 0.498%, an all-time low. On Wednesday morning in New York its was trading at 0.862%, less than half the yield before the Fed policy.

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Bond purchases have had two effects. The program has dropped Treasury and market rates to all-time lows. The 10-year yield reached 0.498% on March 9th in the early market panic, and then revisited that range in early August at 0.515% on the 4th.

Market rates have followed. The nationwide average for a 30-year fixed rate mortgage, the most common home loan in the US, was 3.65% on March 19th. Eight months later on November 19th it was 2.72%, the record low in five decades of history.

The Fed rate policy has another important beneficiary besides US homeowners, Federal, state and local governments. Pandemic spending by governments at all levels and reductions in tax revenue from the spring lockdowns have resulted in record borrowing in Washington and many state capitals. Fed bond purchases have kept the expense of these budget deficits at a minimum.

A second result of the Fed bond program has been the compression of credit market volatility. In 2018 and 2019 the range of the 10-year Treasury extended from 3.233% on October 1, 2018 to 1.499% on August 26, 2019. That is 173.4 basis points.

Over the past year, that is from December as above at 1.919% to the March low at 0.498%, the range has been a comparable 142.1 basis points. The range since March under the new quantitative easing program has been less than one-quarter of that , 45.7 points. Given the volatility in other markets, the impact of the Fed purchases is very clear.

Conclusion and the dollar

The Federal Reserve has made low interest rates the cornerstone of its pandemic banking policy. The reduction of the fed funds rate to a 0.25% upper target was just the opening gambit. The real policy is the purchase program that has kept the 10-year Treasury yield below 1% for eight months and market rates equally low.

Yield forecasts from the Fed governors have the fed funds rate unchanged through the end of 2023. The fed funds is the bank overnight rate. Most market rates cue the 10-year Treasury and that is controlled, and artificially depressed, by the Fed's bond purchase program.

For the economy and the dollar the action is in the yields permitted by quantitative easing.

That is why markets will scour the dry rendition of FOMC discussion for clues to the future of the Fed's bond program,  monetary policy by other means.