Twist and Shout

2011, economy, federal reserve, interest rates 1 Minute

The markets are quivering in anticipation of what the Federal Reserve may or may not announce later today.  The consensus is that it will decide on implementing “Operation Twist.”  In this situation, the Fed would maintain short-term rates while reaching out to lower long-term rates, effectively “twisting” the yield curve. The idea is that lowering long-term rates will encourage borrowing, spending, and investment.

However, lack of money, credit, or liquidity doesn’t seem to be the problem.  The fact is that 10 year Treasury yields are already below 2% and near historical lows.  It seems doubtful that lowering rates further will do much to improve economic conditions. Indeed, Bloomberg reports that 61% of surveyed economists do not believe the action will lower the 9.1% unemployment rate.

Figure 1 Ten Year Treasury Yields

 

Source: Yahoo Finance

So why engage in the operation at all?  Well, the Fed is running out of options.  With short-term rates basically at zero and congressional outcry against more QE, Uncle Bernanke is in a real pickle.  At this point, I think he’s twisting, shouting, and throwing anything he has left at the rising wall of economic worry.

Victor K. Lai, CFA

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One thought on “Twist and Shout”

  1. Victor, of course this isn't 2008 all over, but gosh it looks like it! Treasuries have run way up, and they are rapidly becoming the desired collateral for interbank loans. Eurozone banks have lost ability to rollover short term borrowings and can only borrow from central banks. They are also passing on refinancing longer maturity borrowings because of the significantly higher rates they must pay as of the last few months. Western Europe's bank stocks are pounded down, SocGen by 75%, and politicians are way behind events. Who can blame investors for feeling deja vu? Who knows if our markets will suffer until there is resolution over there?So much for going it alone, I think Americans want some kind of investment game plan, reassurance, and someone they trust to have answers in these turbulent times. I am sure that you are earning your keep this summer!

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