It seems that the yield curve on longer-term Treasuries is going up – and up. And the Fed is puzzled.
Are you kidding me?
From Reuters:
WASHINGTON (Reuters) – The Federal Reserve is studying significant moves in the U.S. government bond market last week that could have big implications for the central bank’s strategy to combat the country’s recession.
But the Fed is not really sure what is driving the sharp rise in long-dated bond yields, and especially a widening gap between short and long term yields.
Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit? If so, there might be less need for the Fed to expand the money supply by buying more U.S. Treasuries.
Or does the steepening yield curve mean investors are worried about the deterioration in the U.S. fiscal outlook, or the potential for a collapse in the U.S. dollar as the Fed floods the world with newly minted currency as part of its quantitative easing program. This might be an argument to augment to step up asset purchases.
This seems like a no-brainer to me. No one wants to go longer out because there’s scant faith in the US government’s ability to pay its bills or the strength of the dollar for that matter. And then there’s the matter of the Fed continuing to buy up the Treasuries floated by the government – on top its purchases of ‘Agencies’.
After lowering short term interest rates to near zero in 2008, the Federal Reserve said at its March meeting that it would buy up to $300 billion in longer-term Treasury securities over six months as part of its efforts to increase the money supply and ease the credit crunch of the past two years. So far, the Fed has bought $130.5 billion or about 44 percent of that $300 billion.
The Fed also has a goal of buying up to $1.25 trillion of mortgage backed securities (MBS) and $200 billion of debt issued by agencies like Fannie Mae and Freddie Mac. The Fed purchases of agency MBS total $507.075 billion so far in 2009.
But last week the benchmark 10-year U.S. Treasury bond yield jumped to a six month high around 3.75 pct, while the spread between 2-year and 10-year bond yields widened to a record 2.75 percentage points.
Economists at Barclays Capital in New York have argued that the Fed should announce plans to increase its planned purchases of longer-dated Treasuries to $1 trillion from $300 billion to drive yields back down, lower home mortgage rates again, and support the embryonic economic recovery.
Let’s see, the Federal Reserve is pursuing an inflationary monetary policy while the US Treasury is pursuing an inflationary fiscal policy. And the bankers want the Fed to enlarge its purchase program.
What could possibly go wrong with that?
