1. Operation Twist reload
A U.S. slowdown of the post 2008 economic recovery coupled with the danger of European contagion
"pushed" the FOMC to vote Wednesday, June 20th for an extension to “operation” Twist. It’s epilogue was
destined to take effect June 30th2012.
More specifically, the New York branch of the Federal Reserve announced $ 265 billion worth of acquisition of
treasuries maturing in 6 to 30 years until the end of 2012. At the same time an equal amount of bonds with
maturities up to six years will be either sold or allowed to expire and paid in full without issuing new ones
instead.
Operation Twist was first launched in 1961. It was introduced as a tool designed to reduce the difference
between short and long terminterest rates. Its purpose is twofold: 1. support the housing market, one of the
main engines of the U.S. economy and 2. budget relieving homeowners who renegotiate their mortgages at
lower rates and release additional funds for consumption.
Operation Twist was reinstated in September 2011. It is in addition to the famous Q1,2,3,4 described in the
March 2012 edition II of this column. Both tools have the same final goal described above. However the
difference between the two is the source of funds destined to purchase bonds with maturities of long duration.
The Q tool uses the “printer” whilst Twist utilizes funds obtained from selling bonds with short maturities (up to
3 years). The consequences of using the "printer" is the dilutiveeffect on the US$. Operation Twist is more
effective in this respect because most funds come from sale of assets, namely short-term bonds.
Most interesting, the immediate bond market reaction relative to the operation Twist reload announcement was
the opposite of what the Fed was counting on. As shown in the chart below the price of US 30 years treasuries
ended the June 18 to 22 weekatalmost the lowestpoint
Source: Reuters
The conclusion that can be drawn is as follows: participants in financial markets who decided since 2008 to
“hoard”liquidities in bonds launched their own operation twist, namely: the sale of bonds coupled with
acquisition of equities. This despite bad news from Europe. Thus we can expect a rich autumn for those who
sow the portfolio seeds with overweight equities. At the same time still worth watching closely will be the
evolution of long-term bonds with significant effects on interest and mortgage rates. Chances are the latter has
“pulled station” for the last time in the downward course. I wish you palpitations-free good returns.
N.B. The conclusions and opinions are those of the author and do not represent the views or recommendations
of Euro Pacific Canada