Yield Curve Targeting

The new tool could enable the Fed to keep yields lower for longer, without necessarily continuing to expand its balance sheet.

Fed chair Jerome Powell.

The US Federal Reserve is studying a potential new addition to its tool kit, commonly known as yield curve control, or what the Fed refers to as yield curve targeting. This would involve the purchase of sufficient notes or bonds to ensure that a desired yield level is maintained for a specific maturity.

Under its current approach to asset purchases, the Fed pre-announces an amount of bonds it will purchase but does not specify the yield it is aiming for. The new tool could enable the Fed to keep yields lower for longer, without necessarily continuing to expand its balance sheet.

Although Fed officials seem reluctant to use the new tool under current circumstances with yields already at low levels, “yield curve targeting remains a distinct possibility later this year,” says Marc Chandler, managing partner and chief market strategist at Ba nnockburn Global Forex.

Yield curve control (YCC) has been used by Japan since 2016 and was recently introduced by the Reserve Bank of Australia. YCC was also used by the US during and after World War II to keep borrowing costs down, so it’s not entirely unprecedented.

“Australia’s policy appears to be working at the moment,” Chandler notes. “The yield curve control, as has been the case in Japan, seems to require fewer bond purchases than one might have expected to maintain the target.”

With some segments of the US yield curve inverting again, Leuthold Group senior analyst Chun Wang says, “The chance of [YCC in the US] is probably much higher than the market currently anticipates.” The recent steadiness of the 10-year Treasury yield “certainly looks like YCC is already here,” Wang says. YCC is “far more palatable than negative rates” and could potentially prevent another episode of an inverted yield curve, he adds.

If there is a bearish steepening in the yield curve, YCC could be used as a cap.