It is time to check back in on our old friend the yield curve. We know that the Federal Reserve is looking to keep the short end of the curve very low, but we are seeing an upward movement on the middle part of the curve (see the change from the 3/30/2020 line to the 11/13/2020 line in the chart above). This is normal. There is only so low that the 10-year Treasury can go, and there is only so much supply that the market is willing to soak up. This means that when there is more and more issuance, yields have to go up to entice investors to take on the risk of holding a longer-dated bond. The Federal Reserve has been doing its best to monetize the debt created by the large deficits over the past six months, and we don’t doubt it will continue to do such going forward.
The Federal Reserve took on a Herculean task earlier this year when it set out to preserve the good functioning of financial markets as coronavirus lockdowns began. That task is not over. Looking back at the fallout from the Global Financial Crisis of 2008-2009, the Fed’s programs designed to directly address the market's problems did not cease until 2015, and it was 2018 before we started to see an unwinding of the swollen balance sheet left over from fighting the GFC (see the chart below). So don’t be surprised by further monetary policy coming out of the Fed to continue to support the recovery for several years to come.
It remains to be seen what options are available to the Fed if capital markets begin to trend lower again. They pulled out most of the stops in the beginning of 2020, but such drastic measures did keep the system functioning. And that may be the best praise that we can bestow upon them.