Bond Tumult Complicates Life for the Fed

The volatility in government bond yields last week compelled several market participants to call on the Federal Reserve to say, or better, do something about it, though such calls have lacked specifics. At the same time, a handful of foreign central bank officials expressed concern that the financial conditions in their own countries are experiencing, to use the words of a European Central Bank official, “undue tightening.” The tumultuousness risks complicating a long overdue evolution in the macroeconomic policy mix pursued by the U.S., including a reduction in what has been excessive reliance on unconventional monetary measures.

The root cause of these developments is, in my opinion and for the reasons foretold in my 2016 book, “The Only Game in Town,” too many years of central banks, particularly the Fed and the ECB, being pushed to compensate for the lack of responsiveness on the part of other policy makers. The use of such measures went into overdrive last March because of the pandemic-induced sudden stop of the economy. The result has been a previously unthinkable doubling of the central bank’s balance sheet to more than $7 trillion, the expansion of its asset purchase program to high-yield bonds, extended guidance for ultra-low interest rates going out at least to 2023 and an often-repeated willingness to do even more.