"Fed Views Jump in Treasury Yields as Sign of Better Outlook
By Scott Lanman and Steve Matthews
May 13 (Bloomberg) -- The Federal Reserve considers the recent jump in Treasury yields more as a reflection of a better economic outlook than a signal it needs to step up purchases of U.S. government debt, according to central bank officials who declined to be identified.
It’s too early to judge the effectiveness of the Fed’s $300 billion plan to buy Treasuries even after 10-year yields climbed 0.65 percentage point since the initiative began in March, the officials said. They added that the goal is to stimulate private lending, rather than to target government- bond rates.
The Fed officials’ stance contradicts the view of firms including BlackRock Inc. that have predicted the rise in yields will prompt the central bank to announce an increase in the size of the program as soon as next month.
“It would be very different if the economy still appeared to be in freefall and yields were backing up, but it’s not,” said John Ryding, founder of RDQ Economics LLC in New York and a former Fed researcher. Increasing Treasury purchases would “fight against what is in my opinion a recovery signal, or a signal that the recession is drawing to a close.”
Chairman Ben S. Bernanke said May 11 that the danger of deflation, or prolonged declines in consumer prices, is “receding” and earlier this month cited evidence the economy’s contraction is easing. The Treasuries market, along with stocks and some commodities, have reflected those shifts.
Ten-year note yields closed at 3.18 percent late yesterday, up from as low as 2.46 percent after the March 18 announcement of the plan to buy long-term government debt. The gap in yields between the notes and 10-year Treasury Inflation Protected Securities, a gauge of the inflation rate expected by investors, hit a seven-month high of 1.64 percentage points last week.
The Standard & Poor’s 500 Stock Index closed at 908.35 yesterday in New York, up 21 percent from two months before. Crude-oil futures reached $60.08 yesterday, the highest level since November.
Fed policy makers committed to buy as much as $300 billion of Treasuries over a six-month period in their March 18 Open Market Committee statement. The aim was “to help improve conditions in private credit markets,” the FOMC said.
“The statement is pretty clear,” Richmond Fed President Jeffrey Lacker, who was the first FOMC member to vote for buying Treasuries this year, told reporters May 8. “It doesn’t say anything about a U.S. Treasury yield” as a target, he said after a Washington speech. “I would urge people to take it at face value.”
The Fed has bought $101.7 billion under the initiative so far, part of its campaign to cut borrowing costs by purchasing assets with the benchmark interest rate near zero. Policy makers in March also decided to boost purchases of mortgage securities this year to $1.25 trillion from $500 billion and buy $200 billion, double the previous amount, of federal agency debt.
Stuart Spodek, BlackRock’s co-head of U.S. bonds in New York, said in an interview last week the Fed “needs to consider increasing its purchases of Treasuries” to “stabilize” long-term yields. He told Bloomberg Television May 11 officials may announce an increase as soon as the June 23-24 meeting. Spokeswoman Melissa Garville declined to comment further.
Another fund manager, James Platz of Mountain View, California-based American Century Investments, expects the Fed to announce further purchases “at some point.”
Should the rise in yields cause mortgage rates to surge, that may prove to be a trigger for a stronger Fed response, said Richard Clarida, a strategic adviser at Pacific Investment Management Co., the world’s biggest bond-fund manager. “That’s going to really, really, really hurt the economy,” Clarida said in a Bloomberg Television interview this week.
Last week, fixed mortgage rates rose for the first time in four weeks, with the average cost of a 30-year home loan climbing to 4.84 percent from 4.78 percent, which was the lowest level in Freddie Mac data going back to 1970.
The increase in Treasury yields, coupled with a drop in consumer prices, is increasing real interest rates for companies. Real investment-grade corporate borrowing costs climbed to 8.34 percent in March, the highest level since 1985, according to data compiled by Bloomberg and Merrill Lynch & Co.
Rising real yields may deter companies from borrowing to invest in new products or factories, delaying an economic recovery, said John Lonski, chief economist at Moody’s Capital Markets Group in New York.
No Specific Target
Bernanke and other Fed officials have said they’re trying to lower mortgage rates and other private borrowing costs without aiming for any specific levels.
“We’re not trying to target a particular interest rate,” Bernanke said in May 5 congressional testimony. “Our objective is to provide more liquidity to the system and to help private credit markets, and I think that it has had some benefit.”
Janet Yellen, president of the San Francisco Fed, said May 5 that higher yields are related to the “bit of optimistic news, good signs in the last several weeks that are reflected in the stock market.”
The situation poses a “dilemma” for the Fed, because if the rise in yields reflects “erroneous market views” about the economy, it will hold back growth, said former Fed Governor Lyle Gramley.
“The Fed is probably scratching its head at the moment and will wait and not react until the smoke clears,” said Gramley, who is now a senior economic adviser with New York- based Soleil Securities Corp.