Operation Twist Failing Already / Its Not The Rates!
A: The fed clearly is worried about global growth and took some expected yet crazy actions today to try to proactively impact longer term yields. Prior to the announcement, 10YR Treasury yields were at 1.92% + 30YR yields at 3.1%, apparently too high for today's appetites - r u kidding me Ben Bernanke! You see, according to the fed, that is why we are not seeing growth...because rates are too high. You have to ask yourself if you really believe that?
Basically the fed announced that rates will remain manipulated until mid 2013 citing "significant downside risks to growth", and that they will sell their short term treasury holdings (aprox $400bln) and use that money to buy longer dated treasuries in an effort to keep longer dated yields down from already record lows. In addition, they will reinvest maturing agency debt principal into buying more agency securities.
The immediate effect this had was to push up short term yields and push down longer dated yields, in effect flattening the curve. This is very non-bank friendly and I just don't understand how in a bank recapitalization environment like we have been the past few years, you would want to do this when long term yields were already pushed to record lows by natural market forces pricing in future downside risks that we already knew about?
I discussed this on Monday stating, "The article also talks about how the fed can sell their short term securities and buy longer dated ones...what would this accomplish really? First off, that would kill the bank recapitalization effort that is ongoing and second the fed naturally will have much more difficulty trying to manipulate rates at the longer end of the curve - their control is at the short end. "
Yet they did it and here we are. Are we no longer even considering potential future unintended consequences of all this action, this manipulation of markets?
On Kudlow this evening one guy (Jim LaCamp) had it right and argued this exact same point (click the image for the video: fast forward to the 4:18 mark):
CNBC transcript: Jim LaCamp: "look, the further you go out on the yield curve, it encourages risk in a yield curve. Where it flattens out, you are not encouraging risk. At the same time ben bernanke is discouraging risk, he's telling you that the economy stinks, too. This makes no sense whatsoever. Ten years & Thirty years yields are sitting at all time lows. They do not need help from ben bernanke and at the same time, we have the bank downgrades going on. This is a serious problem and nobody yet has talked about europe. the three biggest u.s. banks, their debt to gdp is 39%. The three largest french banks are 250%. not only do we have these problems going on here, things are getting worse in europe."Yes, exactly, rates are not the issue here! Thank you Jim LaCamp for speaking some common sense. If you think this is wrong can someone please explain the other side of this one to me, because I just don't get it.
And here is the quote from today that got me to start drinking an hour earlier, courtesy of Yahoo's "'Very Unusual' Fed Action Fails To Boost Animal Spirits: Dow Drops 285":
For the record, former fed governor Mark Olson says he would have voted for Wednesday's action if he were still a voting member of the FOMC. "I would have because I don't see any downside risk to it," he says. "Should inflationary pressures start to build, it's a circumstance where they can adjust that portfolio just a quickly and reduce the size in a way that won't have long-term negative implications."Oh, no downside risk huh with long term rates down so much already without any fed action? Let me ask you this: WHAT HAPPENS IF/WHEN INFLATIONARY PRESSURES DO RISE, AND US TREASURY YIELDS SURGE AS THIS MASSIVE ONE-WAY TRADE REVERSES? The fed is now going to sell $130bln+ in longer dated treasuries onto the open market while everyone else ditches their longer dated treasuries at the same time? What do you think that added selling pressure in the fed's "unwind" will do to yields if/when 'inflationary' pressures actually do start to build, as this guy says? That is what you call a potential unintended consequence of market manipulation, even if it is years away. If rates surge in the years to come right as we start to turn the corner, you can blame the Fed for that one!
The idea that rates are too high now to promote borrowing and growth is short sighted. Rates are already very low right now from the markets pricing in upcoming pressures to global growth; acting as a natural stimulant to invest in riskier assets. We didnt need this added action unless something else is cooking. I fear maybe the fed worries about something deeper in the near future and is taking this action to both appease markets and put forth policy initiatives to prepare for a possible near term event in Europe. I dont know.
By the way, three fed governors dissented this move: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, all who did not support additional policy actions at this time - bravo to these guys. The list of fed dissenters grows, albeit slowly.
Posted by urbandigs
Wed Sep 21st, 2011 09:14 PM
This is the best explanation I can see out there for why the fed did what they did today:
Creditcrumbs comment on this page: http://globaleconomicanalysis.blogspot.com/2011/09/operation-twist-visual-success-yield-on.html?x#echocomments
"Unfortunately, the Fed cannot print too much because the weak economy has made the natural (free market) Fed Fund rate already near 0-0.25%. With rate already that low, it has no justification to print much to reach that rate. Hence, it announced Operation Twist (OT) today. With OT, it sells short term treasuries so that the natural FF rate will go up. With the natural FF rate going up much above 0-0.25%, it has the justification to print a lot more to bring it down to the target rate.
Investors have misunderstood this, I believe. They think that OT is disappointing, so they sell off the market. In my opinion, the opposite is true: OT means massive printing with a potential magnitude larger than $400 billion. This is a buying opportunity for PMs. "
Posted by urbandigs
Wed Sep 21st, 2011 09:27 PM
From Ritholtz: http://www.ritholtz.com/blog/2011/09/thoughts-on-the-feds-twist/
Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.
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The Twist in essence reduces to a bank subsidy. How?
1) Banks are taken out of levered long duration Treasury paper at cycle lows
2) Banks increase their net holdings in the short end on a levered, positive carry basis (by repo-ing purchases of short paper with the Fed)
Is the Fed’s solvency at any lesser or greater risk? NO.
1) Despite the duration extension of the Fed’s balance sheet, there is no incremental risk
2) The Fed must now, however, be THE BID for the long end
3) Real risk to bondholders, regardless of duration, is dollar devaluation (real risk), not rising interest rates (nominal risk)
So, in the near term, banks win, Fed breaks even, dollar and unlevered bondholders risk of devaluation is escalated.
Where from here?
1) Incremental QE is no more or no less needed as a result of The Twist
2) Incremental QE is ABSOLUTELY still necessary to shrink the unreserved debt to base money stock ratio
3) Future QE may very likely require the Fed to bid out through the long end to defend yields across its holdings maturity spectrum
In sum, this is a move to help recapitalize banks under the guise of supporting the housing market and any wealth effect that might flow from that outcome. This is all about the banks income statements. Future and imminent QE will be about their balance sheets (dollar devaluation which then boosts nominal asset/collateral pricing).
Posted by Joshua Gamen
Thu Sep 22nd, 2011 01:32 AM
Sad that we are so aware of changes to our social media but clueless about our money which most of us "don't care about" yet are enslaved to. http://youtu.be/QxahtcEfHyw
Posted by anon
Thu Sep 22nd, 2011 10:23 AM
I must admit this is getting a bit scary Noah. Is this 2008 all over again? While I hear what you are saying about the fed acting too aggressively, what else were they supposed to do given the circumstances? Also, have you seen any effect in the Manhattan markets lately given whats going on in stock markets?
Posted by urbandigs
Thu Sep 22nd, 2011 10:35 AM
anon - yes, it is scary. It was scary over a month ago when US Treasuries were warning us about slowing global growth. But to see the markets spit in the face of the fed, is scary. To see 1.75% 10yr yields is scary. To see whats happening in EU, is scary. The problem is we have to go through this one way or another and its best if central banks keep a close eye on it as it occurs, not try to prevent it. It has to happen. Balance sheets need to be repaired, bad companies need to fail, debts need to get restructured and sovereign nations need to declare bankrutpcy and bondholders need to take big haircuts. Otherwise we are papering everything over and we will be dealing with this for many years to come. Lets purge the system, take the medicine, take the pain, have govt's/cb help with liquidity as needed and fiscal policy as needed to deal with the pain, but lets not prevent the deleveraging or re-organization of balance sheets/debts. If they let it play out, it will hurt yes, but in a few years we will be on much sounder footing for sustainable future growth. Greece is fucked, and the EU wont admit it, even to this day, years after bailouts and injections. Thats one example. I dont get it.
Ill do a piece on real time Manhattan signals later today or tomorrow
Posted by urbandigs
Thu Sep 22nd, 2011 05:27 PM
Ok Ben, 10yr and 30yr rates are now down by 20bps and 30bps respectively..where is the rise in demand???
Posted by anon
Mon Sep 26th, 2011 03:49 PM
How bout those BILLS!!!
Posted by urbandigs
Mon Sep 26th, 2011 06:12 PM
let me say that the Bills looked awesome yesterday and r legit. As long as fitz to s johnson is there and f jax is playing with the heart that he is playing with, the rest of the team will click too. The bills 3-0. The lions 3-0..Its like 1999 again! Loving it
Posted by lalaland
Mon Sep 26th, 2011 10:45 PM
I thought the intention was to force the banks to quit reinvesting in treasuries by making the return so low the banks would invest in - say - loans, or other investment classes with more risk. Krugman had an article positing we were in a low-inflation trap ( http://nyti.ms/pP6lBK ) and with the Euro disaster bearing down on us like a freight train (today's market numbers notwithstanding) it's hard to see what will cause any inflation at all in the near term (commodities are played out except gold, etc.). We need real wage inflation (not outflows via oil) to get us out of this mess, and anything that encourages risk sounds good to me.
Posted by urbandigs
Tue Sep 27th, 2011 07:57 AM
lala - either that or the fed is relieving the banks of all their longer term treasuries from the bank recap environment where they bought borrowed for zero and bought treasuries that were never meant to be held. But flattening the curve doesnt help banks in general, it doesnt promote risk taking or lending. Now the fed is the only bid for longer dated treasuries. I agree on the wage inflation front. We need to A) let consumers and businesses continue to delever and repair balance sheets, and 2) create jobs..anything that helps these two will ultimately lead us out of this cycle