On August 24 we had a blog post speculating that the next version of Fed easing would come in the form of Operation Twist. We made a Chubby Checker joke, too — thinking ourselves somewhat witty! After spending today in front of a CNBC-blaring TV, I’m regretting the pun. Their bumper music… ALL DAY… has been Chubby Checker’s Twist. Please… no more Chubby Checker.
Now, as far as the real Operation Twist is concerned, the details were released today. Overall, the goal is to lower long-term interest rates to 1) drop mortgage refi costs, 2) stimulate demand, and 3) replay the (now classic) move of forcing people into risk assets to create a wealth effect.
The bullet point details are as follows:
- The Fed Funds target rate will remain between zero a 0.25% through mid-2013
- The Fed will sell Treasuries with less than three years of remaining maturity and buy Treasuries with between 6 and 30 years of remaining maturity with the proceeds
- The size of Operation Twist will be $400 billion
- 2/3 of the longer dated purchases will be below 10 years of remaining maturity, the other 1/3 will be longer than 10 years
- The Fed will continue buying mortgage-backed bonds with the proceeds of maturing mortgage-backed bonds
As might be expected, the announcement spurred a buying rally in longer-dated Treasuries. Yield on the 10-year fell to a 60 year low of 1.86% while the 30-year yielded down to an even 3.00%.
The Treasury rally, combined with numerous bank downgrades sent the stock market markedly lower, with the Dow Jones Industrial Average closing at a loss of nearly 285 points. Bank of America, one of the downgraded stocks, fell 7.5% while Wells Fargo dropped 3.9%.
If the Twist performs as advertised, it could put further downward pressure on bank stocks as the yield curve flattens — thereby reducing the spread of which banks have become so fond.
To be truthful, I understand the mechanics of the Fed’s action but I’m baffled by the logic. This continued tinkering on the margin of monetary policy at a time when adjustments to fiscal policy are impossible seems quite likely to end poorly. We’ll be watching things carefully over the next number of days to get a better sense of the impact on risk assets. Monetary twisting hasn’t been done in 50-odd years, so we don’t have much history to rely upon.
And the broken record says… “It’s a good time to keep net exposures low.”