Will $400bn Twist un-stick US economy?

The Federal Reserve has launched 'Operation Twist', a $400bn attempt to control interest rates and boost the flagging US recovery.

by Andrew Saunders
Last Updated: 06 Nov 2012
Markets are in turmoil this morning, with the FTSE 100 dropping by almost 5% after America’s central bank announced plans to sell $400bn of short-dated Treasury bonds (those which are due for payment within three years) in order to finance the purchase of an equal value of long-dated bonds – those with up to 30 years before payment is due. This, it is hoped, will put downward pressure on long-term interest rates in the bond market and thus ease borrowing costs and stimulate growth. It should also mean that the heavily-indebted US government can itself continue to borrow at low rates, but we’re sure that had nothing to do with the decision…

Since the Fed has already pledged to keep the US equivalent of the base lending rate at its historic low until at least 2013, Operation Twist suggest that chairman Ben Bernanke is sufficiently alarmed by the slowdown is US growth and job creation to really pull out all the stops. Coming as it does after yesterday’s signals from the Bank of England that more quantitative easing may be in the offing over here, the news is also likely to herald another bout of Central Bank intervention on both sides of the pond.

So why go for the twist (so called because it’s an attempt to twist the bond yield curve, rather than for any unfortunate gambling connotations) rather than more QE? Well, the key difference is that twisting doesn’t involve changing the size of the Fed’s balance sheet – no ‘new’ money has to be conjured out of thin air as the purchases of long bonds are all funded by sales of short ones.

It’s a sign of the times that a key reason for choosing to do it is to keep the Chinese sweet, who have been bellyaching (not unreasonably) that all those new dollars the Fed has been electronically minting recently has been putting pressure on their exchange rates. But the size of the action means that there is little scope for any further twisting in future – if that proves to be necessary then it will be back to QE again. But at least this way they can say to the Chinese that they have tried…

Fed eggheads have estimated that the impact of the twist should be roughly equal to that of its last $600bn round of QE, although of course that remains to be seen. Interest rates on 30 year Treasuries fell slightly on the news although the stockmarkets reacted defensively, seeing the plan as a further sign of a weakening economy.

What with the Eurozone crisis and the stalling recoveries both her and in the US, it’s hard to disagree with the IMF’s recent conclusion that the western economy is indeed entering a ‘new, dangerous phase.’ But we don’t think it’s time to start stockpiling baked beans and digging a shelter in the back garden just yet…

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