With QE2 Ending, Speculators Envision a QE3 'Cap'
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With QE2 coming to an end tomorrow, the Federal Reserve has been mum on the possibility of QE3. However there is a growing belief the next inevitable foray by the central bank into the market will not just involve another X-billion dollar bond buying program, but rather go directly at capping Treasury yields along the curve.
Under this possible easing measure, the Fed could signal to the market the yield, say, on the 2-year note will be capped at 0.1%. They could also move up the curve and out to the 3-7 year timeframe, or they could even go out to the all-important 10-year. If a program like this is introduced the market will likely move yields to these "capped" rates and the Fed would buy Treasuries as necessary to keep them there.
According to Federal Reserve Chairman Ben Bernanke's own words in a 2002 speech, a program like this would not only cause yields on medium-term Treasury securities to fall, but yields on longer-term public and private debt would likely fall as well. This is due to the link between short- and long-term interest rates. Under normal conditions, long-term rates represent expectations for current and future short-term rates, plus a term premium.
Lower yields across the curve would have the desired effect of boosting aggregate demand.
Doing something like this is not a new idea for the Fed. For nearly a decade prior to 1951, the Federal Reserve had a program that maintained a ceiling 2-1/2 percent on long-term Treasuries. Simultaneously the Fed established a ceiling on the 12-month Treasuries between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. During the period the Fed purchased the bulk of the outstanding 90-day bills, however they were able to enforce the ceiling on long-term bonds without ever holding a substantial portion of the long-term bonds outstanding.
If this doesn't work, Bernanke may have other options including buying foreign government debt or domestic government debt. Buying foreign government debt could impact the forex market, so it would be considered ultra-risky.
Some market participants are expecting an announcement on QE3 and possible treasury caps with the annual Jackson Hole Fed meeting in August.
Under this possible easing measure, the Fed could signal to the market the yield, say, on the 2-year note will be capped at 0.1%. They could also move up the curve and out to the 3-7 year timeframe, or they could even go out to the all-important 10-year. If a program like this is introduced the market will likely move yields to these "capped" rates and the Fed would buy Treasuries as necessary to keep them there.
According to Federal Reserve Chairman Ben Bernanke's own words in a 2002 speech, a program like this would not only cause yields on medium-term Treasury securities to fall, but yields on longer-term public and private debt would likely fall as well. This is due to the link between short- and long-term interest rates. Under normal conditions, long-term rates represent expectations for current and future short-term rates, plus a term premium.
Lower yields across the curve would have the desired effect of boosting aggregate demand.
Doing something like this is not a new idea for the Fed. For nearly a decade prior to 1951, the Federal Reserve had a program that maintained a ceiling 2-1/2 percent on long-term Treasuries. Simultaneously the Fed established a ceiling on the 12-month Treasuries between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. During the period the Fed purchased the bulk of the outstanding 90-day bills, however they were able to enforce the ceiling on long-term bonds without ever holding a substantial portion of the long-term bonds outstanding.
If this doesn't work, Bernanke may have other options including buying foreign government debt or domestic government debt. Buying foreign government debt could impact the forex market, so it would be considered ultra-risky.
Some market participants are expecting an announcement on QE3 and possible treasury caps with the annual Jackson Hole Fed meeting in August.
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