Operation Twist: US Fed has failed and it has no tools left

Remember Operation Twist, announced with much fanfare in the US by the Federal Reserve? If the Fed’s real intention was to push up long bond prices, it failed, but if the desire was to pump up equity prices, success was modest.

[caption id=“attachment_164485” align=“alignleft” width=“380” caption=“On 21 September 2011, the Fed announced “Operation Twist” to bring down long-term interest rates. Reuters”] [/caption]

On 21 September 2011, the Fed announced “Operation Twist” to bring down long-term interest rates. The Fed planned to sell short-term treasuries and buy long-term ones with the money. The goal of the operation was to keep money supply neutral, so that no new money would be printed to lower interest rates. As prices of bonds rise, their interest rates fall.

As always, we will look at what the market did since the Fed announcement to see if it was a success. As with most government intervention programmes, Operation Twist did not succeed, except for a couple of days. It has failed to give the bond market a sense of direction. Ten- and 30-year treasuries rallied on the week of the announcement and have since failed to make a new high. They have turned volatile. ( Click here for treasuries chart) The chart on the top is the 30-year treasury bond future and the one below is the 10-year.

The week the announcement was made is marked by a vertical line with the date at the top. The horizontal lines mark the high of that week. Notice that three months after the announcement, treasury prices of 10- and 30-year maturities failed to close higher. The 10-year did make a slightly new high only to sell off last week. The 30-year also sold off.

Now let’s look at the five-year treasury bond and the US equity index, the S&P 500. ( Click here for the chart ). The chart on the top is the five-year treasury and the one below is that of the S&P 500 futures contract. The five-year notes closed slightly higher in the week to 17 December, but sold off strongly last Friday.

The equity market is another story. On the week of the Fed announcement, the equity markets fell and have since risen. So if the real goal of the Federal Reserve was to bring down interest rates, it failed. But if the Federal Reserve’s goal was to pump up the equity market, it succeeded, but only modestly, as the market did not rally very strongly. The failure of “Operation Twist” raises the question of what the Fed will do next to pump up the economy.

Maybe nothing, as the US economy seems to be picking up with a reduction in the unemployment rate, the rise in retail sales and housing starts and some other positive numbers. This may be transitory and only the future will tell how the engine of the global economy will do.

However, from the Federal Reserve’s point of view, there is little it can do as it has used up most of it’s monetary tools. It can, of course, keep pumping more money like Japan did, but that would fuel global inflation. Also, the Japanese economy has been in the tank for over 20 years despite endlessly printing money. The only rational option seems to be pro-growth US fiscal policies from the White House and Congress.

George Albert is Editor, www.capturetrends.com