Dynamic concept Monetary policy

Yield of ten-year bond – a candidate goal for controlling bond buying size

In my note on May 18, I pointed out that the Fed was turning the bond buying program into a control tool. Those who have no control theory background might feel a little difficult to fully appreciate my thinking.

Since the last FOMC meeting when the Fed seemed ready to reduce the size of the bond buying program, the yield of ten-year bond has jumped from 1.6% to 2.6%, representing a 60% increase. The rapid reactions from the market prompted the Fed boss down played the possibility of early winding down the bond buying program at the Congressional testimony this week. Chairman Bernanke stated that reducing the bond buying is by no means a preset course.

The Fed seems giving up to use the unemployment target of 6.5% as one of criteria to exit loose monetary policy. For the first time, the Fed boss acknowledged that some unemployment had become structural and therefore persistent easy monetary policy is needed to help get these people back to work.

What is more significant ahead is that the Fed might be adopting the yield of ten-year bond as a goal. The Fed will increase or decrease the size of the bond buying to maintain the yield around a goal it sets in the course of exit. The goal shall be gradually ramped up as economic conditions and employment improve. If the Fed adopts this strategy, the exit will be smooth and increase of interest rates will be gradual and modest.