Yield curve control and 

the living dead

If YCC is used once again weak companies that have relied on too much debt will get a new lease of life. The economic support may be necessary, but the outcome will contribute to an ever-growing horde of corporate zombies.

The Lex Column

Jun 25, 2020 – 11.17am

Desperate times call for desperate measures. Central bankers contemplating economic damage wrought by coronavirus are tempted to step up interventions.

Long-term interest rate targeting, aka yield curve control (YCC), could be the next step in financial mobilisation. A renewed feeding frenzy in capital markets has the potential to push inflated stocks even higher.

Extreme monetary policy risks creating hordes of corporate zombies. Supplied

Central bank efforts to support individual economies mean interest rates are already at record lows in Europe, the US and UK. Central banks have purchased corporate bonds along with sovereign debt.

Yet while quantitative easing involves setting nominal monthly purchases of mostly sovereign bonds in order to lower longer-term rates, yield curve control is different. Yields are capped at specific levels along the curve.

Central banks purchase bonds to keep the yields on certain durations at desired levels — capping increases in borrowing costs.

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The strategy has already been put to use. The Bank of Japan (BoJ) introduced YCC that targeted 10-year yields in 2016. The Reserve Bank of Australia began targeting three-year yields in March in response to the current crisis. The US Federal Reserve and Bank of England have been mooted as potential YCC candidates.

Explicit targets might reduce overall central bank intervention. Evidence from Japan shows that bond purchases have fallen since the BoJ started YCC. Inflation, however, remains elusive and well below target levels.

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The flipside is further distortion of market mechanisms. The last time the US started this sort of intervention was during the second world war, when both long and short-term rates were set. That sparked a rally in which US stocks rose by a third in the space of a year.

Price-to-earnings multiples expanded by three points to 22 times within three years, according to Bank of America.

If YCC is used once again weak companies that have relied on too much debt will get a new lease of life. The economic support may be necessary. But the outcome will contribute to an ever-growing horde of corporate zombies.

Financial Times