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An update on the yield curve control in the US

Market Insights 27.07.2020

27.07.2020

 

 

 

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Bruno Cavalier
Chief Economist at ODDO BHF

 

The US economy is exposed to two immediate threats, the first from the virus, the second from the fiscal cliff. The pandemic is seeing another upsurge and Congress has not (yet) decided to extend support to households. After a sharp rebound in May and June, demand has tended to level off in recent weeks. There is a risk that the economy could stall or even relapse. What can the Fed do to minimise this risk? Keeping policy interest rates at zero, providing the necessary liquidity, extending the QE are a given. Some members of the FOMC would also like to strengthen the guidance on longer rates via some "yield curve control". Here we take stock of this key debate for the future of US monetary policy.

The week's focus

After strengthening in May and June, the US economy is showing signs of weakness again. The pandemic had subsided from April to early June, suggesting that the worst was over, but since then it has gained ground in a large swathe of the country. Restrictions on the use of certain commercial premises have been reinstated here and there. In recent weeks, mobility indicators have shown that households are more cautious, staying at home more. This is leading to a moderation of their spending, as reflected in the volume of credit card purchases. The decline in jobless claims has also slowed markedly. On the other hand, there is a fiscal cliff risk, i.e. that the exceptional measures to help the unemployed may not be extended, at least not in full (see p.3). These measures are scheduled to expire at the end of the month. As is often the case, partisan disagreements over the amount and content of the next budget package may only be overcome at the eleventh hour. This is stoking the climate of uncertainty and magnifying the downside risks to activity, employment and inflation.

What can the Fed do to minimise these risks? In the short term, it will continue along the path it has followed in recent months, i.e. of keeping policy rates at zero, serving liquidity needs without restrictions and extending its asset purchase policy. The Fed's assets totalled $ 4,174bn at the start of the year. They rose by $ 3,000bn (+72%) to its recent peak in mid-June. Since then, the balance sheet has tended to shrink (chart lhs). This should not be interpreted as the Fed's desire to tighten its policy, but merely the fact that the markets have returned to their normal functioning, implying a reduced need for liquidity. In particular, the Fed stopped its special repo operations and reduced its dollar swap lines with the major foreign central banks. All told, financial conditions have returned to their pre-pandemic state (see chart rhs).

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Conflict of interests:

ODDO BHF CORPORATES & MARKETS, a division of ODDO BHF SCA, limited sharepartnership - Bank authorised by ACPR. ODDO BHF and/or one of its subsidiaries could be in a conflict of interest situation with one or
several of the groups mentioned in this publication. Please refer to the conflict of interests section at the end of this document.
Le présent document n'est pas un document contractuel; il est strictement destiné à l'usage privé du destinataire. Les informations qu'il contient se fondent sur des sources que nous estimons fiables, mais dont nous ne pouvons
garantir l'exactitude ni l'exhaustivité. Les opinions exprimées dans le document sont le résultat de notre évaluation à la date de la publication. Elles peuvent donc être révisées à une date ultérieure.

 

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