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The Fed could be firing up economic stimulus in disguise

Even as global growth expectations increase and governments pile on fiscal spending measures central bankers are quietly restarting recession-era bond-buying programs.

Driving the news: Comments Tuesday from Fed governor Lael Brainard suggest the Fed may be jumping onboard the global monetary policy rethink and restarting a program used following the 2008 global financial crisis.


What she said: “I am paying close attention to market developments,” she said. “Some of those moves last week, and the speed of the moves, caught my eye.”

  • Brainard added that she would be "concerned" if she saw disorderly conditions or persistent tightening in financial conditions.

What we're hearing: Economists say it's unlikely the Fed will reignite its quantitative easing program as central banks in Australia and Korea have announced in recent days but could restart Operation Twist.

What it means: Operation Twist III, as it's been dubbed by economists (because it would be the third time the Fed has used the tool), would see the Fed selling some of its short-dated U.S. Treasury bonds and buying longer-dated bonds to flatten the yield curve as it did in 1962 and 2011.

Why it matters: In addition to the technical benefits for the bond market, Operation Twist has historically stimulated the economy by pulling down the benchmark 10-year Treasury yield.

  • Because most consumer interest rates — like credit cards, auto loans, mortgage rates — are set based on the 10-year yield, Operation Twist could act as an accelerant for the economy without the Fed having to add to its balance sheet and risk the appearance of concern.

Under the surface: Despite the extraordinarily bullish expectations for booming economic growth in 2021, rate-sensitive sectors of the economy are showing weakness.

  • The housing market has slowed with recent home sales numbers badly missing expectations and CoreLogic's latest Home Price Insights Report noting that "as supply/demand challenges continue to push home prices higher, we may see new barriers for some prospective buyers in 2021."
  • The rate for the traditional 30-year fixed mortgage saw its largest single-week increase in almost a year last week, rising to 3.23%, according to the Mortgage Bankers Association.
  • Auto sales are slowing after a weak 2020, with Edmunds.com estimating sales fell 2.8% last month, year over year, due to smaller tax returns and higher car prices and interest rates, Stephanie Brinley, principal automotive analyst at IHS Markit, told the Detroit News.
  • Credit card balances and other revolving credit lines fell by 10.8% year over year in December (the last month data were reported) the steepest decline ever, according to the Fed's data.

What's next: All eyes will be on Fed chair Jerome Powell Wednesday at a virtual Wall Street Journal event to see if he also is paying close attention to "market developments."

Charted: 5-year inflation expectations hit highest in a decade

Data: St. Louis Fed; Chart: Axios Visuals

In addition to the lightning-fast jump up in nominal U.S. bond yields, the Fed also is likely watching the continued rise in 5-year inflation expectations.

  • While 10-year and 30-year breakeven rates, which measure investors' expectations for inflation over those time horizons, have been capped in recent days as the bond market selloff abated, 5-year breakeven rates have continued to surge higher.
  • The 5-year breakeven rate touched 2.43% on Tuesday, the highest since May 2011.

Got her back: Tuesday's remarks from Brainard were echoed by San Francisco Fed president Mary Daly who told reporters after a speech that the Fed could change the maturity of its bond purchases if the yield curve steepens in a problematic way.

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