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Don’t call it a “twist,” Fed QE rejig will only marginally help yields

Don’t call it a “twist,” Fed QE rejig will only marginally help yields

09 Apr 2021

The Federal Reserve’s plan to recalibrate bond purchases to better match outstanding U.S. debt is likely to provide only marginal support to longer-dated bonds battered by expectations of faster growth and higher inflation, as analysts caution the move shouldn’t be dubbed as a stealth “twist”.

The New York Fed said on Thursday that it could make minor adjustments to keep bond purchases proportional to the outstanding supply.

The comments by Lorie Logan, an executive vice president at the New York Fed and the manager of the System Open Market Account (SOMA), briefly sent long-dated yields lower, though they rose back on Friday ahead of new long-dated supply next week.

“On the margin it should push back against the re-steepening narrative,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets in New York.

But the move is part of existing Fed policy to match purchases to outstanding issuance and not a new way “of trying to influence the shape of the curve or outright yield levels,” he said.

Market participants have been fixated on whether the Fed will intervene to stem the rise in long-dated yields. They are increasing as the economy reopens from COVID-19 related business shutdowns, while deficits widen to records and the Treasury sells unprecedented new supply to finance stimulus.

New Fed support could take the form of yield curve control, where it commits to holding certain yields below a preset level, or with a so-called “twist,” where it increases purchases at the long-end of the curve with proportional cuts to short-dated purchases.

But Fed officials so far have not expressed concern over the rising yields, saying they are based on improving economic expectations. Fed vice chair Richard Clarida said Friday that he would not characterize Logan’s plan as a “twist.”

Twenty-year bonds will likely be the biggest beneficiary. Purchases of these bonds have lagged issuance since the maturity was introduced last May for the first time in three decades.

Gennadiy Goldberg, an interest rate strategist at TD Securities in New York, said any boost would be small, with purchases in the seven-to-20-year sector only likely to increase by around $2 billion per month.

“The impact will be felt pretty slowly,” he said. And “this technical change will basically be overpowered by whatever happens with deficits.”

Treasury Inflation-Protected Securities (TIPS), by contrast, will see modestly fewer purchases.