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What Does Yield Curve Control Mean? - YouTube
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(bright electronic music)
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- [Arno] We have a quick
question here from Kevin
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who asks, "What exactly
is yield curve control?"
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Now recently there's been lots of comments
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in financial news
regarding the possibility
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of some central banks
like the Federal Reserve
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adopting a yield curve control policy.
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And even though it will be new for the Fed
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if they go for it, we do already have
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some other central banks like
the Bank of Japan and RBA
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who currently are using this policy.
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So to start off understanding
yield curve control,
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we need to understand
what the yield curve is.
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So, the yield curve is
basically a representation
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of the type of yield for
various bonds or securities
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of different maturities.
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So, when investors invest
over a shorter time frame
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or shorter time periods, there's
arguably less uncertainty,
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for example, about the next
three months or six months,
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et cetera, compared to the
next 10 years from now.
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So, what normally happens
is for the investor
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that wants to buy longer data securities,
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they will obviously require more yield
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for that increased uncertainty
over the larger time frame
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that they buy the securities in.
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So, to mitigate the risk for
holding longer-term debt,
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investors will require a higher yield,
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and this means that usually
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your yield curve will slope upwards,
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with yields on shorter
durations, securities being lower
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than that of the
longer-duration securities.
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Now the way that central
banks would usually
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affect the yield curve is
by setting shorter-term
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interest rates higher or lower.
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Right?
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So the challenge facing
central banks right now,
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or in any type of economic
crisis like we had
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back in the global
financial crisis as well
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is how to keep the backend of the curve
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from moving significantly higher
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when you already have your
short-term interest rates
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close to zero or at 0%.
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So a possible answer for them to do that
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is yield curve control.
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So with yield curve control,
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the central bank can keep
rates lower for longer,
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which will basically
help the economy recover
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and can also help keep
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the government's borrowing costs lower.
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Now, they do this by basically choosing
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a specific maturity, so later
they choose three-year bonds
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like the RBA.
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They can basically choose a target rate
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for that three-year bond yield,
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let's call it zero spot two five percent,
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again, like the RBA.
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And what they will do
is they'll say, "Okay.
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"We want to keep the three-year yield
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"at zero spot two five percent.
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"And we want to control the
yield curve synthetically
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"by basically buying securities
in whichever quantity
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"in order to peg the rate
at that desired level."
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So this will basically
require the central bank
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to buy securities just like you're in QE,
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but the sole purpose isn't
really in the same sense
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as traditional QE.
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You're basically only buying those bonds
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to try and control the yield curve.
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Now, this will normally
affect the economy.
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Theoretically speaking,
it should be supportive
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for the economy in terms of growth
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as it would keep interest rates low,
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which would obviously lead to
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more businesses being able to loan money,
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more consumers being able to loan money.
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And that should theoretically also lead
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to a weaker currency.
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Now, if the Fed, for example,
opts for a yield curve control
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and keeps their unlimited
QE program at the same time,
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that would probably be seen
or see a lot more U.S. dollar
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downside and could see some further upside
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in things like gold.
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However, as was the case
with the RBA and the BOJ,
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once the central bank
reaches its specific target
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for the yield curve control,
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let's again use that
three-year yield example
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at zero spot two five percent,
they can basically get away
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with far less bond buying in the long term
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because they just need
to maintain the rate
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at that specific level.
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Now, if the Fed opts to replace
their unlimited QE program
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with the yield curve control,
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that could see lots of dollar upside
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as it would possibly
suggest fewer bond purchases
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and would possibly be seen
as a tapering exercise
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from the Federal Reserve.
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So, it's not only about the yield curve,
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but also how the Fed will respond
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to the other policy measures
in line with that yield curve,
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which is also important to keep in mind.
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But that should give you
a broader understanding
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of what exactly they mean
by yield curve control
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and how it theoretically
should impact the economy
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as well as the currency.
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