Yield curve control is an interest-rate policy whereby central banks target specific yields for different bond maturities.
For example, they may keep 2-year treasury rates below the 0.1% target while putting a lid on the 10-year treasury of 1.5%.
After having cut its overnight rate to zero, a central bank can use a yield curve control strategy to set rates for longer term maturities.Central banks implement this tool by pledging to buy as much debt as needed to peg rates at some desired level while keeping an upward-sloping yield curve.
The Perfect Setup for Yield Curve Control
Typically, central banks implement a yield curve control strategy to meet a range of objectives, primarily:
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Keeping government's borrowing costs lower
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Helping the economy recover
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Maintaining the stability of the financial system
1. Keeping Government's Borrowing Costs Lower
High and increasing public debts are only sustainable in a low interest rate environment. This is the case of the US government debt which, already high since the financial crisis, exploded during the global pandemic.
Source: Federal Reserve Bank of St. Louis
2. Helping the Economy Recover (increasing economic growth)
Since the 1980s the US GDP has been waning for decades. The growth collapse after the 2008 financial crisis and specially during the 2020 COVID-19 outbreak gave institutions the perfect justification to implement fiscal and expansionary monetary policies, pursuing the double objective of avoiding the collapse of the global system and helping the economy recover.
Source: Federal Reserve Bank of St. Louis
3. Maintaining the Stability of the Financial System
What central banks fear the most is a market crash that could bring down the financial system. In March 2020, the dollar soared while financial markets were sinking like a stone. Many investors needed to sell liquid securities to meet margin call requirements or protect less liquid assets. As a result the bid-ask spreads on many securities jumped to a point where the corporate bond market became dysfunctional and the Fed decided to intervene aggressively.
How does yield curve control help maintain the stability of the financial system? Treasury yields is a benchmark for investor confidence, corporate yields, and mortgage rates. So stabilizing the yield curve helps support the financial system, particularly in an asset bubble environment
Conclusion
The current situation seems a perfect setup for yield curve control policy since the necessity of meeting these goals are, today, more urgent and relevant than ever:
- The US government cannot afford much higher interest rates
- The US economy is still struggling after the COVID struck
- Financial assets are highly valuated across the board, including stocks, bonds and real estate.
