As was widely expected, the Fed Open Market Committee (FOMC) policy statement today announced its so-called “Operation Twist” plan, with the goal of further lowering long-term Treasury interest rates. According to its own data, the Fed has a Treasury portfolio of apprx. $1.65 trillion. Basically, the Twist involves the Fed replacing its shorter-term Treasury holdings with long-term Treasuries. This would involve selling short-term T-bills and T-notes and buying longer-term T-bonds.
The Fed policy statement indicated that the Fed will sell $400 billion in short-dated Treasuries with maturities of three years or less and replace them with a similar amount of Treasuries with maturities of six years to 30 years. Apprx. 29% of the $400 billion will go into Treasuries dated 20-30 years. The Fed said it would make this transition gradually between now and next June.
Earlier this month, the rate on 10-year T-notes fell to a record low and was at 1.9% ahead of the policy statement today. The 30-year T-bond rate was 3.2% before the statement. Just after the statement, the 30-year bond rate fell to near 3.0%. It remains to be seen how much lower the 30-year yield will go just ahead, especially with inflation well above 3%. Since Operation Twist was so widely anticipated, much of it may already be priced in the current yield curve.
Some observers, including PIMCO’s Bill Gross, warn that if the Fed drives long-term rates down, this will make bankers even more reluctant to make long-term loans. And he has a point – who wants to lend for 10 years at a rate of less than 2%?
You may recall that at the last FOMC meeting on August 9, the Committee inserted new policy language in the statement that said the Fed intends to keep the Fed Funds rate near zero “at least through mid-2013.” Previously, the language had read “for an extended period.” A majority of the Committee felt that a longer and more specific time period would be encouraging to the financial markets. That language was included once again in today’s policy statement.
Here is the link to today’s FOMC policy statement:
http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm
The stock markets plunged immediately after the policy statement was released just after 2:15 EST. Apparently traders were disappointed that the Fed didn’t offer more accommodation. The Dow Jones closed down over 280 points (-2.5%). The S&P 500 fell almost 3%. The US dollar rallied after the report. I look for another wild ride in the markets for the rest of this week.
A Few Comments for New Readers
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I have been in the investment field continuously since mid-1976, and I have been writing in various formats continuously since mid-1977. Those formats include my weekly or monthly paper newsletters up until September 11, 2001. Just after 9/11, I started my free weekly E-Letter as a way to get important information out to my investment clients quicker. My E-Letter now goes out to over 500,000 people each week.
Time flies and it’s now been a decade since I started my weekly E-Letter that you can subscribe to for free at www.forecastsandtrends.com.
Normally, my topics of discussion focus on the economy, investments, the markets and global trends, but I am also an admitted political junkie. While I am not a member of any political party, my political views tend to fall on the conservative side on most issues, which can be frustrating for those on the left.
Nonetheless, I have found that politics has exerted an ever-increasing influence on the economy and our investments over the last decade. As a result, I find myself increasingly integrating political analysis into my economic and investment themes – especially since President Obama took office.
As always, your comments and suggestions are welcomed.
The Fed also purchased “toxic assets” during the initial crisis, in order to stabilize the banking system. If they are now trading in their short-term treasuries for long-term treasuries, wouldn’t that make it even harder to mop up the extra cash when banks and businesses decide to spend again? What would they have that people would want to buy?