Operation Twist

Today the Fed announced a new measure called operation twist. The idea behind this move is that they will be selling about 400 billion dollars in short maturity bonds (3 years or less) and will use the proceeds to buy an equivalent amount of bonds of longer maturities (6 years or more). This will have no effect on the Fed’s balance sheet because they will be selling the same value of assets as they will be purchasing. However, this will extend the average maturity of bonds that the Fed holds from 6 years to just over 8 years. Part of the Fed’s logic is that short term rates cannot raise very much because the Fed Funds rate is practically 0% and the Fed has pledged to keep it there until at least mid-2013. On the other hand, they do believe that the purchases have the ability to drive long term rates lower. The 10-year yield is considered to be an important benchmark for mortgages so any reduction could potentially help support weak home prices and make mortgages more affordable.

There is a pretty widespread belief that the Fed’s move today will have almost no effect on the general economy. If the Fed’s round of QE2 in which they purchased 600 billion of long term securities had no measurable impact on the economy, then surely “operation twist” which is dealing in lower sums and doesn’t even expand the Fed’s balance sheet will likely not have any substantial effect either. 61 percent of economists polled by bloomberg predicted that the move would not have a meaningful impact on unemployment and 15 percent thought it would have a potentially harmful effect. Todays drop in the dow of 2.5% was further proof that Fed’s move is not being met with great hope from investors. The best thing that could be said about today’s move is that it drove many of us to listen to an old classic.