Fed Does Twist

September 21st, 2011 at 5:48 pm

As expected, the Fed announced that they’ll shift the composition of their bond portfolio, selling $400 billion in short-term bonds and using the proceeds to buy bonds with longer term maturities. Why?  As the WaPo put it:

The strategy is often called a “twist” operation, because it simultaneously pushes long-term rates downward and short-term rates upward. And that is exactly what happened in financial markets after the announcement: At 2:40 p.m., 30-year Treasury bond rates had fallen 0.16 percentage points, while two-year rates had risen 0.04 percentage points.

Equity markets thought $400 billion was pretty wimpy and tanked on the news (on the other hand, that move in the 30yr is actually pretty big–see charts below).  There is no magic number here—it’s mostly about expectations and signaling.  In this regard the Fed (i.e., the non-dissenters) signaled:

–they view the economy as needing more stimulus;

–thanks for your input, R leadership, but we got this…;

–they’re not necessary done easing;

So, unless Congress gets it together and kicks some additional fiscal stimulus into the mix, we’re stuck in Box 3, which is better than 4, but not good enough.

Here are some reaction charts from today’s markets–the twist predictably led to an increase in the yield of 6-month Treasuries, a fall in the 30-year, and a sharp sell off in the Dow, which just said ‘to Hell with all of ya’:

Source: WSJ

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2 comments in reply to "Fed Does Twist"

  1. Dan Furlano says:

    Since you are reading up on MMT I thought I would post a link to a paper by Scott Fullwiler and how interest on reserve balances could theoretically replace treasuries and reduce the interest paid on the national debt.

    Basically it would be combining the Fed and Treasury operations. Now that’s a twist.