by Mitch Kokai
Senior Political Analyst, John Locke Foundation
The Fed used to observe the tradition of mainly limiting its buying and selling to short-term Treasuries, whose market value is relatively stable. No more.
Because of QE, it now holds more than $1.7 trillion worth of mortgage-backed securities, most with maturities exceeding 10 years. Also, bonds with maturities of more than 10 years make up about a quarter of the nearly $2.5 trillion in Treasury securities currently held.
Far from being concerned about the radical departure from past policies that quantitative easing involved, however, the Fed is actively replenishing its stock of long-term securities as older ones mature. It is thus still engaging in a kind of quantitative easing on easier terms. “By keeping the Federal Reserve’s holdings of longer-term securities at sizable levels,” the background report declares, “this policy is expected to help maintain accommodative financial conditions by putting downward pressure on longer-term interest rates and supporting mortgage markets.”
Whether such efforts are really necessary to keep the economic expansion going is open to question. But because the value of long-term bonds falls when long-term interest rates rise, our monetary mandarins are now playing massively with interest-rate risk. If long-term rates do rise faster than anyone now anticipates, the Fed may run into difficulties of navigation that could prove a tad destabilizing to the economy.
Also off the charts: the Yellen Fed’s practically phobic fear of hiking the interest-rate target on federal funds.
In her testimony, Yellen was right to point out that, while the employment situation has been improving, and “domestic spending and production have been increasing at a solid rate,” the expansion still isn’t quite operating on all eight cylinders.
But Fed actions are supposed to be pre-emptive, anticipating what is to come. Hence a full-throttle expansion has never been a requirement for a nudging-up of rates. Ten years ago, a central banker reading her testimony couldn’t have imagined that the interest-rate target hadn’t been raised in nine years, much less that it had been at a shockingly low 0% to 0.25% for more than six years.