Monetary policy: breaking down 10-year US$ Treasury Yields

Monetary policy in the spotlight Piet Lammens

Monetary policy after zero rate bound is reached

23 september 2013 2

Monetary policy after zero rate bound is reached (part 1): QE

23 september 2013 3

Determination 10-year Treasury yield

ECONOMIC DATA

LIFT – OFF DATE

FORWARD GUIDANCE

SLOPE OF OIS CURVE

TERM PREMIUM

QUANTITATIVE EASING

10-YEAR YIELD

QE pushes term premium sharply lower

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Real 10-yr yield (left) versus 10-yr breakeven (right)

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US 10-year yield

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QE objectives

Objective: lower longer term interest rates Stimulate aggregate demand. Change demand/supply

dynamics FI market

Push investors towards riskier assets (equity/corp) Influence composition portfolio investors

Scarcity channel/duration channel/expectation

channel

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QE costs

Inflated balance sheet Exit policy more difficult Fed effectively lost rate setting power

Excess reserves: banks no longer dependent on Fed Remedies are possible, but jury is still out (IOER, reverse repo at FAFR)

Artificially pushing term (risk) premiums

down: recipe for bubbles 23 september 2013 9

QE & Fed communication/evaluation

QE program linked to “substantial” improvement labour market. (1 yr: 8.1% to 7.4%)

Time path Bernanke (June FOMC meeting)

Costs programme increase (bal. sheet) and risks increase (Fed Stein: signs of overheating in some credit markets)

Criticism mounts (impact growth negligible: favours the haves versus the have-nots). 23 september 2013 10

QE end-game

Start tapering at Sept. FOMC meeting

Start?: $15/20B Pace: Dec $20B, March & June14 $20/25B Evenly divided between MBS & Treasuries Data-dependent, but asymmetrical risk Largely discounted? Sell-off May/June?

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Determine 10-year Treasury yield

ECONOMIC DATA

LIFT – OFF DATE

FORWARD GUIDANCE

SLOPE OF OIS CURVE

TERM PREMIUM

QUANTITATIVE EASING

10-YEAR YIELD

Monetary policy as zero bound is reached (part 2): Forward guidance

History (Fed- BoE – ECB) Objective: influence curve beyond short term

horizon Promise about future rates (data-dependent/time-

dependent/undefined time period)

Conditional Credibility

Has reaction function CB changed?


Forward Guidance Fed

Fed version March 2009 - August 2011: commitment to keep rates

low for an extended period August 2011: explicit calendar guidance (at least

through mid-2013, later shifted backwards) Dec 2012: tied to unemployment rate & inflation

• Unemployment rate 6.5%- inflation max. 2.5%, expect. anchored thresholds, no triggers

June 2013: QE tapering tied to unemployment rate too


Forward Guidance

Fed tries to convince markets QE tapering has nothing to do with forward guidance FF Possible changes to FG: lower unemployment rate

threshold to 6% and/or floor for inflation (1.5%)

Markets have doubts (see recent curve moves)

ECB & BoE forward guidance lacks credibility


Fed’s lift-off date


Fed Funds projections (governors)


Dec 2014/2015 FF future & increased rate expectations


VS: Fed funds rate expectations


Unemployment & participation rate


Fed projections unemployment rate


Fed projections GDP growth


US core inflation


Time path ST Euribor/Libor3m rates


Forward Guidance & markets

Shift forward in lift-off date Fed rate change is not completely out of line with Fed guidance

Eco data to remain key Uncertainty high about fundamentals after crisis Quid productivity? Potential growth? Output gap?

Simultaneous shift forward ECB & BoE official rates, even before better eco date

• Signs of normalization after debt crisis to happen faster? • If so, rate hike expectations still too shy


1994 revisited?


KBC interest rate forecasts (Aug)


POLICY RATE 2/sep 3m 6m 12mUS 0.25 0.25 0.25 0.25EMU 0.5 0.5 0.5 0.5

10 YR YIELD 2/sep 3m 6m 12mUS 2.82 2.8 2.8 3.3GE 1.9 1.8 1.8 2.1

10-year Inflation swaps


Determining 10-year US T-yield

ECONOMIC DATA

LIFT – OFF DATE

FORWARD GUIDANCE

SLOPE OF OIS CURVE

TERM PREMIUM

QUANTITATIVE EASING

10-YEAR YIELD

ECB policy

No pre-commitment was guiding principle Inflation objective sacro-saint 2% was the unofficial bottom of rates

Now: refi-rate: 0.5% LTRO loans FA/FF: liquidity enhancing

ECB lost power over money market rate Eonia (& euribor) drop below refi-rate


ECB historical July decision

New tool: Forward guidance rates will remain ‘at present or lower levels for an extended period of time’ Easing bias: 50 bps is not floor All rates are envisaged: keeps open possibility of neg. deposit rate ECB wants to influence rates further out on the MM curve End of “we never precommit” mantra

“Extended period” should be seen in terms eco data, not calendar dates, but… It suggests no tightening until at least end 2014/mid 2015 Attempt to dissociate ECB policy from Fed policy & European yields from US

ones (success poor in 1994) EMU economy too weak to withstand higher yields Is commitment credible or sounds it hollow?

Fed leads the way in good & bad days


EMU: refi-rate expectations (euribor 3m)


German 10-year yields more upside?


Business

Monetary policy: breaking down 10-year US$ Treasury Yields