June 29, 2020
In general, the public doesn’t think about the Federal Reserve, the “central bank” for the United States. Given the pandemic, and the initial economic chaos, the Fed jumped in and certainly has been in the news ever since. As a reminder, it performs five general functions to promote the effective operation of the U.S. economy and, more generally, the public interest. But Orion’s brokers are most focused on the Federal Reserve conducting the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. And promoting the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad.
In addition to bringing back forward guidance and quantitative easing during the coronavirus pandemic, Fed officials are now talking about yield curve control, sometimes called interest rate caps. But just what is yield curve control, and how might it impact the rates you give to borrowers?
In normal times, the Fed helps steer the economy by raising or lowering very short-term interest rates. Under yield curve control, the Fed would target a longer-term rate and pledge to buy enough long-term bonds to keep the rate from rising above its target. This would be one way for the Fed to stimulate the economy if bringing short-term rates to zero isn’t enough. Yield curve control is different from Quantitative Easing because QE deals in quantities of bonds while yield curve control focuses on prices of bonds. Under QE, the Fed might announce that it plans to purchase $1 trillion in Treasury securities. Because bond prices are inversely related to their yields, buying bonds and pushing up their price leads to lower longer-term rates.
Under yield curve control, the central bank commits to buy whatever amount of bonds the market wants to supply at its target price. Eventually, the target price becomes the market price in the bond market, since who would be willing to sell the bond to a private investor for less than they could get by selling to the Fed? And since securities backed by mortgages usually trade based on a fluctuating spread to various points of the yield curve, movements impact mortgage pricing from Orion and other investors as well.