Moderate, With a Twist
I know, many of you think Ben Bernanke is some crazy Keynesian, Helicopter Ben distributing your dollars on the economy like so much pixie dust.
It's not true.
I am glad I waited until tonight to write this because we needed some distance from the Fed's decision to engage in Operation Twist Part Deux. ("What's Part Une?" you say. There you go.) It was anticipated that the very unusual two-day meeting of the Fed, along with a five-page statement at its end, would be earth shattering.
It was not. It was about as mild a move as you could make given the sizzle Bernanke had sold for weeks starting at Jackson Hole.
In short, the Fed will sell $400 billion of its holdings of short-term Treasury securities -- which by tradition has been 100% of its portfolio -- and will use the proceeds to buy long-term U.S. Treasuries. By doing so it hopes to reduce long-term interest rates which more closely track commercial and mortgage loan rates. If they are successful, homeowners refinance and have extra spending cash, and businesses are induced to invest more by lower borrowing costs.
Operationally, the Fed is going to do this in 8 $50 billion steps between now and June 2012. At $400 billion, this is smaller than QE2 by a third, and as a share of GDP smaller than the original Operation Twist in 1961. The paper linked above estimates that the effect of the original Twist was 0.13-0.16% on 10 year Treasuries. So the real question has to be whether the effect this time wouldn't be 2/3 of that? As I write this near midnight ET the day after, the 10-year Treasury fell 0.14% from the pre-announcement level.
Will it help? Yes, a little. If the Fed does not stop easing here, the next stop would be a 10-year rate at 1.5%, about where we were at the worst of the Great Recession. It might make GDP grow a little more than 2% vs the current expectations of 1.5%, but not much more. That will not be enough to make a big dent in unemployment. That, plus the Fed's statement that the economy was weakening may explain what's happened in markets today. (That and the continuing dithering in Europe over Greece.)
The Fed is hemmed in. It has a dual mandate to promote both price stability and high employment. The Republicans may not like it -- if so, they should change the mandate to just the former, as has happened over the last 20 years in many other countries. (Happens to be my own little corner of geekery.) Let someone drop that bill in the House hopper tomorrow. But even with a more liberal dual mandate, the Fed has three bank presidents who again have stood for more hawkish policy. 'Twas ever thus at the Fed, and I'd just as soon see the GOP Congress leave well enough alone, though I agree with Matt Yglesias that politicians speaking on monetary policy is meet and right so to do. That and the more conservative bank presidents will give you results like yesterday, which I think will turn out better than either conservatives or liberals think.
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Sep '10
Re: Moderate, With a Twist
Unfortunately we don't print money at the fed like they used to, cotton prices are high "http://money.cnn.com/2011/03/08/news/economy/dollar_cotton_prices/index.htm". They simply create money using the computer. Also I follow many other thinkers on this that have called these bubbles for what they are. This is far from over and the market has not bottomed out.
Also on price stability, in a free market would cause prices of manufactured/commodities to fall based on advances in technology along with competition. Yet all I have read about is continual devaluation of the dollar. I may be young but why is the candy I used to buy nearly double from 15 years ago? This isn't natural or healthy.
Apr '11
Re: Moderate, With a Twist
Banks borrow short-term in the form of deposits and lend the money out long-term. If the Fed flattens the yield curve by forcing down long-term rates,why should this be seen as an incentive for banks to make loans? All I can see that it does in increase the level of risk for banks.
And I don't see the obsession with focusing all of the attention on revivifying the consumer end of the housing business as particularly healthy - and I say that as one whose home value collapsed by one-third to one-half in the last few years. Trying to prop-up home prices as opposed to letting them fall to the natural market-clearing level only seems to prolong the agony while simultaneously destroying the value of household savings and investments through the inevitable inflation to come.
Sep '10
Re: Moderate, With a Twist
I have been waiting for your post. Generally I think the Fed follows the market more than it influences the market. It is anybody’s guess what effect the twist will have on longer term rates, but as confidence wanes in the US’s ability to get its financial house in order longer term rates will rise. Since there is no longer official M3 figures published I have difficulty ascertaining the velocity of money, but if I am correct it turned negative several months ago and remains so today. I think this is far more significant than any twist and beyond the Feds influence. Is there a good source for M3? For the first time in a while almost everything went down the last 2 days except the dollar and longer term treasuries. I think this may well have been more than a reaction to the Fed statement. The markets may be beginning to tell us defilation is not far away.
Feb '11
Re: Moderate, With a Twist
Reduction of long-term interest rates also reduces the income of individuals and corporations with money invested in debt securities in this range of maturities..hence, these people and corporations will have *less* money to spend, offsetting any additional spending by people who are able to refinance mortgages at a lower rate.
Sep '10
Re: Moderate, With a Twist
If they already have money invested in LT Treasuries hey are making a killing as they appreciate. There biggest problem is deciding when to sell. I wish I had this problem - got out way too early. LT corporate and junk bond rates have begun to rise. This strikes me as not a good sign.
Feb '11
Re: Moderate, With a Twist
Liberal Jim...correct for the existing bond holdings IF they are in a position to sell; however, their future investments in this class of assets will still generate lower income.
Many elderly people choose to keep their money if "safe" investments such a savings accounts and CDs; these assets of course do not benefit from any price appreciation when rates fall, and savings accounts and CD rollovers are hit hard by lower rates, resulting in these people having lower spendable incomes.
Sep '10
Re: Moderate, With a Twist
David Foster: I agree with you. People who have worked hard and saved, ie: been responsible need to realize that it is now a question of how best to protect what you have. A few % points in interest seem small if you have half your life savings wipe out. Many are going into higher rate bonds or dividend paying stocks looking for more interest at just the wrong time.
Jun '11
Re: Moderate, With a Twist
Two thoughts.
1. If my memory serves me correctly, there a period in the late 90's during the bailout of LTCM when our Central Bank along with other Central Banks were aggressive net sellers of gold. That bottomed the bullion market after a brutal, bloody 28 year bear market in the metals complex.
2. Mr. Bernanke buys the long end of the yield curve - which is also the riskiest time frame - with note and bond prices near all time highs. What happens to that position if growth ticks up? Look at a chart of the TLT which mirrors the price of the 20 year maturity. Look at a long term chart of Treasury yields. It has been a rip roaring 30 year bull market in bonds.
Did Bernanke just top the bond market?
Re: Moderate, With a Twist
Liberal Jim: M3 from Shadow Government Stats. Good call; the inflation/deflation cycle is very apparent in John Williams' data.
michael: The Fed is saying about 29% of its purchase in Twist will be 20s and 30s, which would be just about the entire supply. Credit Suisse is calling a 2.5% rate on 30-years over this time. TLT is off a bit this AM, but most of the gains yesterday are holding up. The Fed is going to manage the rate through next summer, regardless of GDP figures I think. Obama is sending Bernanke reinforcements on the Board of Governors to keep the hawkish presidents at bay, and they change next January anyway.
Jun '11
Re: Moderate, With a Twist
King Banaian: Liberal Jim: M3 from Shadow Government Stats. Good call; the inflation/deflation cycle is very apparent in John Williams' data.
michael: The Fed is saying about 29% of its purchase in Twist will be 20s and 30s, which would be just about the entire supply. Credit Suisse is calling a 2.5% rate on 30-years over this time. TLT is off a bit this AM, but most of the gains yesterday are holding up. The Fed is going to manage the rate through next summer, regardless of GDP figures I think. Obama is sending Bernanke reinforcements on the Board of Governors to keep the hawkish presidents at bay, and they change next January anyway. · Sep 23 at 8:12am
King, when you say "manage rates," do you mean the Fed will try to control the intermediate and long end of the yield curve? Doesn't economic growth of or lack thereof have more to do with where rates go?
This is an interesting move by the Fed. Maybe they have the balance sheet to sustain a position on the riskiest yield curve over time but if the world starts selling Treasuries, it turns into a tough bet.
Re: Moderate, With a Twist
michael kelley
King, when you say "manage rates," do you mean the Fed will try to control the intermediate and long end of the yield curve? Doesn't economic growth of or lack thereof have more to do with where rates go?
That will be the catch. If the Fed thinks we're in a liquidity trap, then growth might not have much to do with it, at least over some range of growth. Get to 5% GDP growth and all bets are off.
Dec '10
Re: Moderate, With a Twist
If the Fed is going to sell the short term Treasuries, whom will buy them? Also, will they just get "purchased" by straw entities, that then quietly sell them back to the Fed? How will we ever know if they aren't just buying more Treasuries, covered by a fake sale of the short term notes?
Jun '11
Re: Moderate, With a Twist
King Banaian
michael kelley
King, when you say "manage rates," do you mean the Fed will try to control the intermediate and long end of the yield curve? Doesn't economic growth of or lack thereof have more to do with where rates go?
That will be the catch. If the Fed thinks we're in a liquidity trap, then growth might not have much to do with it, at least over some range of growth. Get to 5% GDP growth and all bets are off. · Sep 23 at 8:36am
Thank you King for your response.
Last 2 questions if you have time:
1. If this works, wouldn't it make a great case for getting long bank stock? A lot of regionals are trading below their book values. A wave of refinancings along with new mortgages issued, all of that questionable paper being washed clean? Bank stocks from a fundamental perspective could be the best buy on the street.
2. Do you think this will force financial institutions to drop mortgage rates to, say, 3%? Or lower?
Re: Moderate, With a Twist
The Fed's balance sheet is pretty detailed, and you can even see the off-balance-sheet items like the Maiden Lane facility that stored stinky Bear Stearns loans the Fed bought. I think Europe wants more T-bills to use for collateral for their upcoming bailouts. The market craves safety right now, and we're still the safest place in the world to store liquidity (not a statement about our strength but their weakness.)
Re: Moderate, With a Twist
michael kelley
1. If this works, wouldn't it make a great case for getting long bank stock?
2. Do you think this will force financial institutions to drop mortgage rates to, say, 3%? Or lower? · Sep 23 at 9:22am
I am not a stock adviser, so take this as just some other guy speculating. But you raised a point earlier about the intermediation spread (deposit vs loan rate) narrowing. That's not good for profits. If the banks are trading at lower multiples out of fear of default that the Fed has helped reduce, and that could be a reason to trade.
A friend here in central MN just spoke to his bank this week. Current rates on a 15-year mortgage were 3.25%. That's pre-Twist. If we're getting 10-year T's to 1.5% and 30s to 2.5%, you could get that last quarter-point off. Not sure I'd worry too much about timing a bottom here, but the refi market is still weak.
Jun '11
Re: Moderate, With a Twist
King Banaian
michael kelley
1. If this works, wouldn't it make a great case for getting long bank stock?
2. Do you think this will force financial institutions to drop mortgage rates to, say, 3%? Or lower? · Sep 23 at 9:22am
I am not a stock adviser, so take this as just some other guy speculating. But you raised a point earlier about the intermediation spread (deposit vs loan rate) narrowing. That's not good for profits. If the banks are trading at lower multiples out of fear of default that the Fed has helped reduce, and that could be a reason to trade.
A friend here in central MN just spoke to his bank this week. Current rates on a 15-year mortgage were 3.25%. That's pre-Twist. If we're getting 10-year T's to 1.5% and 30s to 2.5%, you could get that last quarter-point off. Not sure I'd worry too much about timing a bottom here, but the refi market is still weak. · Sep 23 at 10:20am
Thanks for the perspective.