Wednesday, September 21, 2011

Operation Twist is over-hyped

With 10-yr Treasury yields trading at historic, record lows, we need lower yields to stimulate the economy?

As we wait to hear from the FOMC regarding whether they will embrace the much-hyped Operation Twist strategy, I have to believe that the market will be disappointed. For my money, 10-yr yields are as low as they need to go already. Either the Fed will not embark on a new "twist" strategy, or they will do it in a very modest fashion to show that they are concerned about the economy, but it won't make much, if any difference, to the monetary policy fundamentals.

UPDATE: The FOMC announced a shift in its existing holdings which involves the sale of $400 billion of securities of 5 years maturity and less, coupled with the purchase of $400 billion of securities with maturities of 6 to 30 years, and a decision to reinvest principal payments from existing MBS in new MBS. Thus there will be no material expansion of the Fed's balance sheet. This leaves the major thrust of monetary policy intact, while fiddling around the edges with the yield curve. Given the existing extremely low level of longer-term Treasury yields, I don't see that this policy announcement will have much impact on the overall health of the financial market or the economy.


Benjamin Cole said...

The Fed should be thinking about sustained QE and a targeted nominal GDP level.

We are doing a Japan. The CPI is up three percent in last three years, and probably overstates inflation.

We know that low interest rates, following a real estate bust and credit freeze, are not enough. Japan has proved that.

Doing nothing (the GOP favorite, at least until they get into the White House) is also not enough--it is, in effect, passive tightening.

The dithering do-nothing Fed looks evermore like the Bank of Japan. Oh, they beat inflation, Good and hard. Maybe forever.

Of course, that's great if you do not mind losing 80 percent on your stock and real estate portfolios in the next 20 years. Like Japan.

The flag of the Rising Sun--seen hoisted over the Fed Building in DC.

Donny Baseball said...

No, but they sure as hell whacked the long stock/short bonds trade. When all this gets unwound, it'll be the trade of lifetime, but who will be solvent by then?

Charles said...

This policy is a big zero. It will accomplish nothing at all, zilch. It's like building a pipeline from Daytona Beach to Tampa to reduce the level of the Atlantic Ocean and raise the level of the Gulf.

John said...

Sometimes investors are their own worst enemy. Market reaction (DOW down 323 this AM) to the Fed move seems like a gross over-reaction.

bob wright said...

Would you be willing to share why you thought the market would be disappointed in Operation Twist?

bob wright said...

Just out of curiosity, was Western Asset managing money for LeggMason during your tenure?

Scott Grannis said...

bob: I thought the market was going to be disappointed because an Operation Twist cannot possibly create a meaningful improvement in the underlying economic fundamentals. In retrospect, it looks like the market was counting on the Fed to do a QE3 as well (either by buying more Treasuries on net, or eliminating interest on excess reserves). I didn't think another easing was likely, since the economy hasn't deteriorated enough and inflation by all measures has increased.

Western Asset has been a subsidiary of Legg Mason since the mid-1980s, and has managed money for its parent ever since.