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Yield curve control: even less likely, for now

Aug 19 (Reuters) - The Federal Reserve on Wednesday threw a bucket of cold water on implementing U.S. yield curve control as a means of keeping the cost of borrowing low, at least near term, after investors formerly thought it could be announced as soon as September.

Earlier in the summer, some bond market players had become convinced that one of the Fed’s next moves would be to cap yields at a specific point on the curve, by buying 2- or 3-year maturities for example. The Federal Reserve indicated in minutes from its June meeting that they had studied it, but was skeptical.

That skepticism was even more apparent in Wednesday’s minutes from the July meeting which said most thought they would likely provide “only modest benefits in the current “environment.”

“The biggest surprise in today’s minutes was the tone shift surrounding yield curve caps,” said Jefferies economists Aneta Markowska and Thomas Simons, who described the minutes as appearing to “pour a bucket of cold water” on the idea.

Bond yields have traded near historic lows in recent weeks due to ongoing bond purchases, zero bound interest rates and guidance from the Fed that interest rates will not be raised for several years.

“They did basically dismiss it as a near-term policy instrument,” said Michael Kushma, chief investment officer of global fixed income at Morgan Stanley Investment Management. They appeared to say “we don’t really need it because we can achieve our objectives without it.”

Low borrowing costs help businesses but discourages savers and pushes investors to take on more risk in the hunt for yield.

Benchmark 10-year note yields rose to 0.686% after the minutes, from around 0.664%. They have risen from 0.504% on August 6, the lowest on record except for one day in March.

While yield curve control may be off the table for now, the Fed is focusing on a policy review that may give inflation more room to grow before rates are increased. If yields do rise to levels that seem harmful to the economic recovery, then Fed officials may try to talk them down, analysts said. The Fed could also increase bond purchases, or shift more of its current program to longer dated debt, to help push yields lower.

Gennadiy Goldberg, Senior U.S. Rates Strategist at TD Securities, said while the Fed did not commit to extending the average maturity of bond purchases this fall, it was leaving the door open to doing so as early as September, when the next Fed meeting will be held.

“The takeaway for me was there are a lot of very intense discussions happening and the lack of commitment now doesn’t imply the lack of commitment later,” said Goldberg.

While yield curve control may seem unnecessary now, that doesn’t mean it won’t be implemented if better growth momentum and supply indigestion push yields higher, said Jefferies.

Still, there are reasons to be wary of going down the path.

“You have to be quite comfortable committing your entire hypothetical balance sheet to achieving that goal,” said Goldberg.

Writing by Megan Davies; editing by Dan Burns and Diane Craft

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