Markets are awaiting the U.S. Federal Reserve’s decision today, Wednesday, September 16, with most analysts and investment banks expecting it to raise interest rates by 0.25% from their current level of 3.5% and 3.75%, amid continued inflationary pressures in the United States.
Bond yields put pressure on credit costs
The rise in government bond yields has revived debate over the impact of higher credit costs on the U.S. economy and its implications for monetary-policy deliberations. Analysts say the U.S. central bank will resist any explicit call from the administration of President Donald Trump to intervene to rescue the market.
Pressure in the Treasury market has raised questions about whether the Federal Reserve could be asked to buy government debt to reduce supply and cap or lower yields, easing government and private-sector borrowing costs. However, observers rule out such a move unless markets collapse and enter a period of turmoil, with little evidence of that so far despite the steady decline in prices.
Rick Rieder, BlackRock’s chief investment officer for global fixed income, said: “One of the unwritten mandates of the Federal Reserve is to improve financial conditions.” Policymakers influence the cost of debt by adjusting short-term interest rates.
Rate hike has mixed impact on yields
Market participants believe a rate hike could support the Treasury’s position by strengthening the Federal Reserve’s credibility in combating inflation, potentially helping to gradually lower long-term bond yields.
A Deutsche Bank survey of investors, published on Monday, showed that raising interest rates now could lead to a slight increase in short-term yields, while long-term yields could rise more sharply if the Federal Reserve kept interest rates unchanged.
Most analysts agree that greater pressure from the Treasury to push the Federal Reserve to buy bonds in large quantities and cap yields would be unacceptable to central banks. Economists, however, argue that previous purchases helped calm turbulent markets, demonstrated the Federal Reserve’s commitment to accommodative monetary policy and may have kept borrowing costs at lower levels.
Monetary-policy independence
Debate over coordination with the Treasury has resurfaced following remarks attributed to Federal Reserve Chair Kevin Warsh indicating a greater willingness to coordinate on certain issues. During and after World War II, the Federal Reserve limited borrowing costs at the Treasury’s request, before ending the practice after the 1951 Treasury-Federal Reserve Accord, which separated government debt management from monetary policy.
John Williams, president of the Federal Reserve Bank of New York, said this September that higher yields “reflect the strength of the economy,” alongside elevated levels of technology investment. He played down Treasury interventions as a factor influencing Federal Reserve policy, adding that what the Treasury is doing “does not complicate my job or our job of setting monetary policy.”
Yields on 10-year U.S. Treasury bonds rose during trading in the available information to record levels above 5% for the first time since 2007, increasing markets’ focus on the relationship between the rate decision and government and private-sector borrowing costs.
