The eventual unwinding of the Federal Reserve’s monetary accommodation with financial regulation uncompleted has lifted risk in U.S. debt markets, according to former Federal Deposit Insurance Corp. Chairman Sheila Bair.
The Fed has kept its benchmark interest rate close to zero and more than tripled its balance sheet since 2008 to about $3 trillion as part of its efforts to sustain growth following the collapse of the subprime-mortgage market. Policy makers last month added $45 billion in Treasuries purchases a month to the $40 billion of mortgage-backed bonds it has been buying since September, in its latest round of quantitative easing.
“We are really in uncharted territory,” Bair said in an interview on Bloomberg Radio’s “The Hays Advantage” with Kathleen Hays and Vonnie Quinn. “We had highly accommodative monetary policy leading into the subprime crisis, but nothing like near-zero interest rates for several years. You do create asset bubbles with this amount of liquidity and it’s difficult, it’s very difficult to get out.”
Yields on 10-year Treasury notes tumbled to an all-time low of 1.379 percent in July. They were 1.86 percent today.
“You have a lot of investors that have been loading up in bonds,” said Bair, now a senior adviser at Pew Charitable Trusts. “They all think that when the market starts to turn they can get out first. You can get that kind of herd mentality and you can get some real problems in the bond market.”
Risks of rising bond yields when the Fed begins to exit its easy monetary policy are exacerbated given that many rules related to the Dodd-Frank Act to stem systemic risk in the financial sector have seen delays, she said. Dodd-Frank derivatives rules, originally intended to be in place in July 2011, have been delayed as the government seeks feedback on how to bring swaps under its oversight.
“The good news and the bad news is that as the economy starts to improve, and we hope it will, to control inflation the Fed is going to have to start raising interest rates,” Bair said. “What impact that’s going to have on the bond market, we just don’t know. We need to be looking forward to those kinds of challenges instead of still trying to get Dodd-Frank in place. It really should have been done a long time ago.”