Pegging the yield on the 10-year Treasury

by Laura Ehrenberg-Chesler on June 6, 2013

in equity market,Fed policy,Fixed Income,inflation/deflation

The recent back up in interest rates has a lot of investors wringing their hands. The yield on the 10-year Treasury is trading around 2.10% and mortgage rates are above 4% for the first time in months. Any time there is the mention of the Fed slowing, or stopping their purchase of bonds, the markets begin to worry by driving rates higher.

One interesting solution, proposed by Ed Yardeni, suggests that the Federal Reserve peg the 10-year Treasury at a specific rate to create a ceiling, and minimze the speculation and the concern. I am not sure how they would do this mechanically, but it is certainly

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a novel idea.

“The recent backup in bond yields, particularly in Japan and the US, complicates life for all the central bankers who have been pushing the outer limits of QE. To keep us from going into the darkness, they have taken us to the brink of monetary policy’s final frontier. The positive interpretation is that bond investors have concluded that the central bankers will succeed in stimulating self-sustaining economic growth and in boosting inflation rates. If so, then the monetary authorities do need to provide a credible exit plan from QE that won’t push yields back up to levels that depress economic activity. Alternatively, central bankers are in a Catch 22 situation in which rising yields depress economic growth, forcing the continuation of QE or even more of it!

What should they do? What can they do? What will they do? When he was just a simple Fed governor, Ben Bernanke provided the answer in a remarkable speech on November 21, 2002 titled, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” In it, he listed all the possible tools that central banks could use to avert deflation including ZIRP, QE, and even printing money. The major central banks have followed Bernanke’s advice except for actually running the printing presses, which is the ultimate final frontier of monetary policy.

However, other than printing money, there is still one tool mentioned by Bernanke that has not been used, i.e., pegging bond yields. Here is what he had to say on the subject: “A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt….”

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