Sticking with the Fed for another post and working on the assumption that at some point, maybe a couple years out, buyers of U.S. Treasury paper will begin to demand more interest than the Treasury can afford to pay (forcing the Fed back into the market on a net basis) here are a couple articles that may be of interest, so to speak.
First up, from the Federal Reserve Bank of New York's Liberty Street Economics blog, April 6, 2020:
How the Fed Managed the Treasury Yield Curve in the 1940s
The coronavirus pandemic has prompted the Federal Reserve to pledge to purchase Treasury securities and agency mortgage-backed securities in the amount needed to support the smooth market functioning and effective transmission of monetary policy to the economy. But some market participants have questioned whether something more might not be required, including possibly some form of direct yield curve control. In the first half of the 1940s the Federal Open Market Committee (FOMC) sought to manage the level and shape of the Treasury yield curve. In this post, we examine what can be learned from the FOMC’s efforts of seventy-five years ago.
Lessons in Yield Management
The FOMC’s efforts offer two lessons in yield curve management:
1. The shape of the yield curve cannot be fixed independently of the volatility of interest rates and debt management policies.
During World War II the FOMC sought to maintain a fixed, positively sloped curve. The policy left long-term bonds with the risk characteristics of short-term debt but a yield more than 200 basis points higher. At the same time, the Treasury pursued a policy of issuing across the curve, from 13-week bills to 25-year bonds. Faced with investor preferences for the higher yielding, but hardly riskier, bonds, the System Open Market Account had to absorb a substantial quantity of bills. A flatter curve and/or a less rigid interest rate policy might have required less aggressive interventions.
2. Large-scale open market operations may be required in the course of refixing, from time to time, the shape of the yield curve.
After 1946, Federal Reserve officials pursued a program of gradual relaxation of the wartime regime, beginning with the elimination of the fixed rate for 13-week bills, continuing with incremental increases in the ceiling rate on 1-year securities, and then moving further out the curve, with the ultimate goal of a free market for all Treasury debt. Following the elimination of the fixed bill rate in 1947, investors began to move their portfolios into shorter-term debt. The result was a massive shift in the composition of the Open Market Account as the Account bought bonds and sold bills to accommodate the changing maturity preferences of private investors....
....MUCH MORE, including further reading.
And from the Federal Reserve Bank of Chicago's Economic Perspectives, No. 2, October 2021:
Yield Curve Control in the United States, 1942 to 1951
Introduction and summaryBeginning in 1942, the Federal Reserve helped the U.S. Treasury to finance war debt by pegging interest rates on short-term Treasury bills (T-bills) at a fixed interest rate and capping rates on longer-term Treasury securities. This episode provides an interesting antecedent that modern central bankers might review in trying to understand the potential costs and benefits of yield curve caps or targets. Indeed, the Fed’s policymaking body, the Federal Open Market Committee (FOMC), recently noted that its committee members had reviewed this episode, along with other more recent episodes of yield curve targeting in Japan and Australia.1 In this article, I review both the onset and the end of yield curve control.
Regarding the onset, I highlight a few basic takeaways for the modern central banker. First, yield curve control can cause a central bank to lose control of the size and maturity distribution of its government securities holdings. As long as investors were unwilling to hold Treasury bills at 3/8 percent, the Fed had no choice but to acquire whatever quantity of bills the Treasury issued. Indeed, the Fed’s yield curve targeting in this era eventually led it to acquire large amounts of Treasury bills, which had low investor demand given a steeply upward sloping yield curve.
Second, I offer a new explanation of why the Fed’s acquisition of T-bills did not immediately follow the advent of its yield curve targeting. Although scholars have appealed to incomplete communications or lack of credibility, these explanations seem incomplete, as contemporary discussions show that sophisticated investors understood Fed policy within a couple of months and believed it to be credible. Instead, I suggest another factor that temporarily generated an increase in demand for Treasury bills during 1942: a special standing facility for buying and selling Treasury bills that created a de facto interest on excess reserves system.
Third, the episode was rife with significant tension between the Fed and Treasury, serving as a useful reminder of the disagreements that can accompany such far-reaching actions by a central bank. The T-bill facility itself was a compromise struck to manage a conflict over how to manage the short end of the yield curve while keeping long-term interest rates low. Overall, these tensions persisted, in one form or another, until the Treasury–Federal Reserve Accord in 1951.
The unwinding of the yield curve control regime with the 1951 accord offers its own lessons. One such lesson is that the end of yield curve control will cause capital losses for investors holding longer-term securities if long-term yields rise. Here I focus on the mortgage market in particular and note that some downward pressure on the supply of mortgage credit appears to have resulted in response to these capital losses to lenders. A second lesson is that yield curve control can lead financial firms to create business models that are predicated on complete stability in government security prices. In this case, the accord transformed the fixed spread between mortgage rates in government programs and Treasury rates into a floating spread. In other words, yield curve control can change not only the expected level of interest rates but also their expected volatility. In this episode, the business models of financial institutions, once disrupted, took some time to be reformulated, resulting in temporary tightness in credit availability....
....MUCH MORE
As noted in the introduction to February's "‘Black Swan’ Author Nassim Taleb Is Feeling Gloomy, Says U.S. Is In A Death Spiral":
It's not the debt, it's the interest.
Well, the debt too but the terrifying question is "What price will investors demand for giving their money to the U.S. government?"
The problem gets serious when the price (interest rate) becomes unsustainable and the Federal Reserve has to resume their bulk buying of treasuries, actually monetizing the Federal deficit. That's where hyper-inflation comes from, issuing debt to pay the interest.
Coincidentally, Havenstein, like Jerome Powell was an attorney, not an economist, though J-Pow will have left the Fed by the time the monetizing starts in earnest, sometime early in the next decade....
Just ask Rudy Havenstein,
Reiterated in April 2's "A Million Simulations, One Verdict for US Economy: Debt Danger Ahead" with the outro:
So keep an eye out for a buyers strike in treasuries leading to the Federal Reserve basically funding the government by creating money to buy treasuries.
Related, March 20:
"Hotshot Wharton professor sees $34 trillion debt triggering 2025 meltdown as mortgage rates spike above 7%: ‘It could derail the next administration’"
So YCC first as a way station on the road to full-on monetization.
In the meantime though, Partaaay!
