Analyst at Danske Bank took a look into ongoing discussions on how the Federal Reserve could strengthen its forward guidance, signaled by them as the central bank’s main concern, “from both a theoretical and practical point of view”.
Key Quotes:
“We argue that the Fed is considering implementing a cap on 3yr US Treasury yields at 0.25% (the upper end of the Fed’s target range), i.e. the Fed can accept the yield trading below but not above the cap.”
“The Fed may have to buy the whole market if the policy is not credible and interest rates may move higher for both good and bad reasons.”
“Outcome-based forward guidance is stronger and more positive for risk than time-based forward guidance like the ‘temporary asymmetric operational inflation target range’ discussed at the January meeting. The idea is to accept inflation moving above the 2% target to make up for a period with inflation below 2%.”
“We expect the Fed to implement a mix of yield curve control and an average inflation target at its September meeting. We believe the Fed recognises the drawbacks of a stand-alone yield curve control policy. We consider some sort of average inflation targeting as better for risk than yield curve control policy.”
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