An interesting speech yesterday from Fed governor Lael Brainard where she discussed further tools the Fed could be considering over the coming period. Focus fell on the role yield curve caps could play in future strategies that may be deployed. Her idea is that the Fed would concentrate their purchases in the “short to medium range” of the maturity spectrum and this would work alongside forward interest rate guidance. A typical example would be that the Fed commits to holding rates low for two years, so no interest rate hikes for a given period, and then using asset purchases to cap two-year yields at a given level for that two year period.
Importantly, she does not appear to be encouraging a steeper yield curve although obviously capping short to medium term yields would automatically infer this; this may be the difference from the system seen in Japan with its yield curve control (YCC). The fact that asset purchases in the past were used to signal to the market that interest rates were not going to rise anytime soon and so became an important source of the reinforcement of forward guidance; this strategy would do the same but would be a lot more explicit.
Other areas of interest include the problems associated with credibility around average inflation targeting in the long-term, but she thought that it could be useful and easier to communicate if imposed temporarily. We feel this was aimed at the 2% Fed inflation target and the criticism the Fed had received over this last expansion where the rate has failed to hit the target.
Looking at the entire speech the Brainard rate cap idea is just one such tool the Fed could introduce out of many under discussion. However, it does appear listening to Brainard and other Fed members as though the goal of the Fed’s Monetary Policy review next year is to reinforce the inflation mandate, prevent persistent downside deviations and discuss strategies that would deliver policy stimuli quickly and effectively in a downturn. Broadly, this review is now taking on a dovish spin as seen in the yield cap discussion and the Fed members constantly referring to problems with persistently low inflation.