The 1960’s called. They want the Twist back.

In the 1960’s, the Federal Reserve embarked on a maneuver known as the Twist.  Simply put, the Twist involved the Fed selling short-dated Treasuries and using the proceeds to buy longer-dated Treasuries.   Legend has it that this would drive down borrowing costs and stimulate economic growth.

I mention this due to today’s market activity in gold, Treasuries, and stocks.  To wit:

  • Gold — Gold fell by $94.10 today.  This would not be expected if the gold markets anticipated QE3 coming this Friday.  QE3 would further debase the US Dollar and gold, as a dollar-denominated commodity, would be a beneficiary.  Conversely, no QE3 would be a disappointment for gold.
  • Treasuries — the 5-year Treasury saw its yield jump by 7.76% today to close at a yield of 1.01%.  If Treasuries were anticipating QE3, we should have seen yields on the short-end drop, not spike.
  • Stocks — the DJIA tacked on 144 points today, finishing the past 2 days with a 4.3% gain.  This could indicate anticipation of QE3, or it could mean something entirely different…

Which leads me to the Twist.

The Twist would have little if any impact on the value of the dollar — hence the disappointed gold market.  The Twist would cause short-end yields to rise as the Fed sells off short bonds — hence the rising yields on the short-end.  The Twist would be advantageous to stocks if (elusive) economic growth came from lowering long-term rates.

Taken by themselves, each point doesn’t particularly say anything.  But taken together, the markets may be telegraphing their opinion that the Twist is upon us.

Stepping back, the Twist may be the most sensible solution at this point.  Any kind of massive QE3 would be met with overwhelming political resistance.  A total lack of QE3 would be met with overwhelming stock market disappointment.  The Twist, on the other hand, helps savers by increasing short rates and helps borrowers by lowering the long ones.  It should help stocks as mentioned earlier.  The Twist won’t help gold, but the Twist doesn’t care about that.  It’s been said by the author of the Twist (Bernanke, not Checker) that “gold isn’t a currency, ” so who should care about the value of that “barbarous relic.”

I guess we’ll have to wait until Friday to see if the markets have any ability to predict Fed policy.

Until then…  it’s just around and around and up and down.

The Bernanke Put? More like Ka-put.

Yesterday’s stock market rally (on the news that savers will be earning negative real returns for the next two years) was all about Bernanke attempting to place another giant “put” option under risk assets by forcing cash into the market.  Remember, at Jackson Hole he overtly indicated that Fed policy is designed to create a “wealth effect” by driving up the value of 401(k)’s, stock portfolios, and all things risk.

And it worked for a while.  The market rallied 100% from its March 2009 lows.  Never mind that the basic commodities required for luxuries such as eating were inflated as well.  And never mind that food inflation is driving double-digit wage inflation across the emerging markets where our consumables are produced.  But, that’s fodder for a different blog post.

The point of today’s blog is really to point out how short-lived was the new Bernanke Put.  After today’s 4.4% loss, the market is only a fraction of a point from yesterday’s pre-Put opening level.   European banking news and rumors swamped the Put.  Whisperings of Soc Gen potentially being insolvent drove its stock down 20%.  The major US banks were all down in the neighborhood of 10%.  Gold continued to rally.  Treasuries continued to rally.  It looks like the Put had the opposite of its intended effect — it drove money out of risk assets and into safe haven assets.

Over the next few days we’ll see if the Put is able to recover for the longer term.  If it does not, there may be no alternative left for the Fed but to launch QE3.  At that point, it may well be a snake swallowing its tail.

For informational purposes, below is today’s Treasury market activity.  It strikes me as a dramatic flight to quality.

Yield            Change in Yield

2-Year                                      0.18%                   -8.37%

5-Year                                      0.90%                  -9.45%

10-Year                                  2.08%                   -7.36%

30-Year                                3.48%                    -3.77%