Operation Twist 2 – Federal Reserve Shifts Bonds

On 9/21/2011 the Federal Reserve’s Federal Open Market Committee (FOMC) announced it will:

• Extend the average maturity of its existing holdings of Treasuries.
• Swap $400 billion worth of shorter-term maturity Treasuries /government bonds with longer-term Treasuries by the end of June 2012.
• Reinvest principal payments from agency mortgage-backed debt/securities back into mortgage-backed securities.
• Maintain near zero fed funds rate (0 – 0.25%), and sees economic conditions that warrant it being kept through mid-2013.

 

The FOMC confirmed the highly anticipated move that it would revive the 1960’s era program known as “Operation Twist”.  It intends to purchase $400 billion worth of longer-term Treasuries (remaining maturities of 6 to 30 years) and sell an equal amount of shorter-term Treasury securities (remaining maturities of 3 years or less), by the end of June 2012.  The goal is put downward pressure on longer-term interest rates (flatten the yield curve) and “help make broader financial conditions more accommodative” in an attempt to improve capital inflows, as well as strengthen the US dollar.

The committee also stated that it will “now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities” and maintain rolling over maturing Treasury securities.  The Fed hopes this action will help support the mortgage markets.

The Federal Reserve also decided that it will maintain its target federal funds rate at 0 to 0.25%, as it anticipates “low rates of resource utilization and a subdued outlook for inflation over the medium run”.  The Fed committee expects that these economic conditions will warrant the near zero rates through the middle of 2013.

In addition, the FOMC revised its outlook on the economy downwards citing “significant downside risks to the economic outlook, including strains in global financial markets”.

 

Implications Of Operation Twist 2:

The Federal Reserve’s latest decision also confirmed that there is no new round of stimulus through asset purchases like there was in QE1 and QE2.  Federal Reserve chairman, Ben Bernanke, had faced internal resistance from policy makers who dissented against keeping the interest rate near zero until mid-2013 on 8/9/2011.  Operation Twist 2 today, seems to have been a compromise likely intended not to provoke dissenting FOMC members, or members of Congress who are concerned that additional expansion of the balance sheet (quantitative easing) would increase inflationary pressures.  However, the 7-3 vote shows that a divided FOMC remains, and it is likely difficult to implement any larger stimulus measures.

The latest monetary policy decision will probably do little to reduce the U.S. unemployment rate which sits at 9.1% (very high).  As I’ve mentioned many times before, the key to economic recovery is with jobs.  Until employment improves, the economic risks falling back into a technical recession. But as far as I’m concerned, we are still very much in a recessionary environment.

It now appears that the Fed is powerless and has run out of ideas & options.  I see the FOMC’s move today as pushing the problems further down stream, which will eventually have to be dealt with in a very painful manner.  It is also unlikely that the latest action from the Fed will spur confidence, encourage consumers to spend, nor get investors to take risks. Corporations will be reluctant to expand (which means new jobs will not be created).

Equity markets are likely to remain very volatile and the economy to remain very weak.  I reiterate that it is a stock picker’s market and will be for some time, as the market indices will likely continue on its roller-coaster ride.  It is less likely that ETF holders of the major stock indices will see large returns compared to returns from individual stocks.  The U.S. dollar may gain strength in the short term (from capital inflows or speculation of inflows).  But I do not think there will be enough actual capital inflows to sustain much increase to the dollar (also due to reasons mentioned in previous paragraph).  U.S. debt problems will also continue to add downward pressure, which may limit any increase in the American currency.

I recommend that investors re-read my previous article Investor Considerations On The Recent Market Decline, particularly the buy/sell/hold considerations & opportunities for some perspective and direction:

 

Official FOMC statement on 9/21/2011:
•  http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm

Thanks & Happy Investing! — The Investment Blogger © 2011

Author: The Investment Blogger

I’m a private investor, who developed the “function-centric investing” paradigm. I am an investor who blogs a little here and there, rather than a blogger who invests a little here and there. I'm passionate about investing and sharing investment knowledge!

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1 Comment

  1. Added to last paragraph some additional thoughts related to the U.S. dollar:

    The U.S. dollar may gain strength in the short term (from capital inflows or speculation of inflows). But I do not think there will be enough actual capital inflows to sustain much increase to the dollar (also due to reasons mentioned in previous paragraph). U.S. debt problems will also continue to add downward pressure, which may limit any increase in the American currency.

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