Young Research & Publishing Inc.

Investment Research Since 1978

Disclosure

  • About Us
    • Contributors
    • Archives
    • The Final Richard C. Young’s Intelligence Report
    • You’ve Read The Last Issue of Intelligence Report, Now What?
    • Dick Young’s Research Key: Anecdotal Evidence Gathering
    • Crisis at Vanguard
  • Investment Analysis
    • Bonds
    • Currencies and Gold
    • Dividend Investing
    • ETFs & Funds
    • Investment Strategy
    • Retirement Investing
    • Stocks
    • The Efficient Frontier
  • Investment Counsel
  • Dynamic Maximizers®
  • Retirement Compounders®
  • Free Email Signup
  • Dick Young’s Safe America

Time for the Fed To Stop Babying the Bond Market

February 24, 2021 By Jeremy Jones, CFA

By Zdorov Kirill Vladimirovich @ Shutterstock.com

At The Financial Times, Richard Bernstein suggests the Federal Reserve begin a tough-love campaign with the bond market. He writes:

The Ferber Method, a sleep training technique, teaches babies to self-soothe and fall asleep on their own. It’s as much a training technique for new parents to ignore their baby’s crying as it is for the child to learn to cope by themself.

The US Federal Reserve should consider Ferberising bond investors and ignore future “taper tantrums” like the market disruption that occurred when the central bank signalled tighter monetary policy in 2013. The long-term health and competitiveness of the US economy may depend on bond investors’ self-soothing ability to cope with reality.

The slope of the yield curve is a simple model of the profitability of lending. Banks pay short-term rates on deposits and other sources of funds and receive longer-term rates by issuing mortgages, corporate loans, and other lending agreements.

A steeper curve, therefore, is a simple measure of better bank profit margins, and has in past cycles spurred greater willingness to lend. Historically, the Fed’s Survey of Senior Bank Lending Officers shows banks have been more willing to make loans to the real economy when the yield curve has been steeper.

With that simple model of bank profits in mind, textbooks highlight the Fed’s control of short-term interest rates as a tool to control lending. The Fed reduces banks’ cost of funding and stimulates lending when it lowers interest rates. But it increases funding rates and curtails lending when it raises short-term rates. Coupling lower short-term rates with a steeper yield curve can be a powerful fillip to bank lending.

However, policies in this cycle have been unique. As US short-term interest rates are near zero, the Fed has attempted to further stimulate the economy by buying longer-dated bonds and lowering long-term interest rates. Those actions have indeed lowered long-term borrowing costs in the economy, but banks’ willingness to lend has been constrained because lending margins have been narrow and risk premiums small.

Banks in past cycles might have been willing to lend despite a relatively flat yield curve because they could enhance narrow lending margins by using leverage. However, regulations after the financial crisis now limit their ability to use leverage.

This policy and regulatory mix has fuelled some of the growth in private lending. Private lenders are not subject to regulated leverage constraints and can accordingly lend profitably despite a flat curve. The growth in private lending effectively reflects an unintended disintermediation of the traditional banking system. This has meant liquidity destined for the real economy has largely been trapped in the financial economy.

The yield curve has started to steepen, and the Fed should freely allow long-term interest rates to increase for monetary policies to benefit the real economy more fully. Allowing long-term rates to increase would not only begin to restrain financial speculation as risk-free rates rise, but could simultaneously foster bank lending to the real economy.

Read more here.

Share this:

  • Email
  • Twitter
  • Facebook

You Might Also Like:

  • The Fed Drowns Bond Market Signals
  • Fed Makes a Mockery of Corporate Bond Market
  • Investors Devour Bonds
  • Author
  • Recent Posts
Jeremy Jones, CFA
Jeremy Jones, CFA, CFP® is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Richard C. Young & Co., Ltd. was ranked #10 in CNBC's 2019 Financial Advisor Top 100. Jeremy is also a contributing editor of youngresearch.com.
Latest posts by Jeremy Jones, CFA (see all)
  • Banks Prepare for Boom - April 13, 2021
  • Larry Summers: Stimulus “Substantially Excessive” - April 12, 2021
  • Wall Street’s New Sub-Prime Borrower - April 9, 2021

Search Young Research

Most Popular

  • Don't Chase Yield Off a Cliff, Do This Instead
  • Vanguard Wellesley (VWINX) vs. Wellington (VWELX): Which Fund is Best?
  • The Power of a Compound Interest Table
  • The Biden Backlash
  • The Highest Yielding Dow Stocks
  • Your Survival Guy Stock: Witness This Dividend Miracle
  • Trains: A Big Deal, and the Economic Future of America
  • You're Telling Me Friends Ask You This Question
  • April RAGE Gauge: Are Your Bond Funds Dead or Alive?
  • Which Industries Are the Biggest Losers From a Biden Global Minimum Tax?

Don’t Miss

Default Risk Among the Many Concerns with Annuities

Risk and Reward: An Efficient Frontier

How to be a Billionaire: Proven Strategies from the Titans of Wealth

Could this Be the Vanguard GNMA Winning Edge?

Cryptocosm and Life After Google

Warning: Avoid Mutual Fund Year End Distributions

Is Gold a Good Long-term Investment?

How to Invest in Gold

Vanguard Wellington (VWELX): The Original Balanced Fund

What is the Best Gold ETF for Investing and Trading?

Procter & Gamble (PG) Stock: The Only True Dividend King

The Dividend King of the North

You’ll Love This if You’re Dreaming of an Active Retirement Life

RSS The Latest at Richardcyoung.com

  • Your Port Against a Storm.
  • CBS – Picking on the Ron Guy
  • RECONSTRUCTION: The Confiscation of All His Property
  • Questionable 2020 Races in New Hampshire Will Get Forensic Audit
  • Blue Dog Democrats Must Stop the Squad’s Assault on America
  • Move from Mass., Conn., Vermont, Maine to New Hampshire
  • Biden Should Leave the Economy Alone
  • Demography Is Destiny: You Will Rise and Stand
  • How About Giving North Conway, NH a Visit?
  • Lost Kitchen of Freedom, Maine, Booked a Year Ahead 

About Us

  • About Young Research
  • Archives
  • Contributors

Our Partners

  • Richard C. Young & Co.
  • Richardcyoung.com

Copyright © 2021 | Terms & Conditions

loading Cancel
Post was not sent - check your email addresses!
Email check failed, please try again
Sorry, your blog cannot share posts by email.