The Fed Has Trained Bond Traders Not to Push Yields Up Too Far

The message from the bond market after the latest brief leap in yields is clear: The Federal Reserve is standing by to prevent an alarming increase in rates, no matter how much debt the Treasury sells amid the pandemic.

Investors have been acting for months as if the Fed has already unleashed one of the remaining tools at its disposal -- yield-curve control, a policy of capping rates to keep them from rising too quickly and squelching an economic rebound. And this week has been no exception.

The old adage of “Don’t fight the Fed” is at work here. The mere prospect of central-bank action is keeping yields close to historic lows. In the world’s most important debt market, yields are stuck in a range so tight it has few precedents, even after rates reached a four-month high Wednesday on hints that a U.S. coronavirus-relief package could be taking shape.

As they have for months, buyers emerged to bat yields back down. The purchasing preserved the sense of calm in fixed income that’s persisted despite the Fed’s August pledge to let the economy run hot to fuel inflation. That episode merely stoked demand as yields climbed toward 1%. These are telling lessons for investors across asset classes, less than two weeks before U.S. elections that could pave the way for an even bigger wave of government spending.

Yields stick to a range as Fed looms large

“Yields are almost behaving as if we have yield-curve control already,” said Esty Dwek, head of global market strategy for Natixis Investment Managers, which oversees about $1 billion. “The yield rise will probably remain contained because the Fed is more important than anything else and they will limit it.”

Call it stealth yield-curve control, as Fed policy makers have pushed back on the idea of capping yields. It’s a step that central banks in Australia and Japan have already taken. The Bank of Japan has been pinning 10-year rates at around zero, while the Reserve Bank of Australia targets three-year yields at 0.25%.

In the U.S., yields have been boxed in from both directions. On the upside, the potential for Fed action should the economic picture darken, along with overseas buying and haven demand because of worries about the pandemic, are keeping long-term yields in check. On the downside, the central bank’s reluctance to drive policy rates below zero creates a floor.