What is Operation Twist? Some call it QE 2.5

This forum is created to discuss everything about Investing, from investment principles, to theories, concepts, strategies to investment jargons to provide a easy reference for everyone

Moderators: alvin, learner, Dennis Ng

Post Reply
Dennis Ng
Site Admin
Posts: 9781
Joined: Tue Nov 29, 2005 7:16 am
Location: Singapore

What is Operation Twist? Some call it QE 2.5

Post by Dennis Ng »

What is Operation Twist?

Market watchers are anticipating a new measure from the US central bank to stimulate the economy: a radical change in the make-up of the Fed's portfolio of government bonds

Economists and financial traders believe the Federal Reserve will announce a new stimulus measure dubbed "Operation Twist" after its monthly meeting on Wednesday. Can "twisting" (changing the composition of the government bonds held by the Fed) put the US economy on a firm footing?

What is Operation Twist?

When you play the card game pontoon, you have the option to "stick" – keep the hand you are holding – or "twist" – draw another card. Until a few months ago, the Federal Reserve believed it had a strong hand in the battle to kickstart the US economy and was prepared to stick. But recent events have shown the economy struggling and unemployment staying high. Now it must twist.
What happens in practice?

Over the last two years of quantitative easing, the Fed has acquired a hand that includes $1.65 trillion of federal bonds – in other words, loans to the US government. Some of these bonds will mature in one or two years, some not for much longer – up to 30 years. If the Fed trades in some of its shorter-dated bonds for more of the longer-dated alternatives, demand for the longer-dated variety will exceed supply. This in turn will drive up the price of those bonds, which depresses the "yield" – the effective rate of return the holder of the bond gets on their investment. The yield determines the interest rate. Lower long-term interest rates will lead to lower 25-year mortgage rates, car loans and other bank lending rates.
Does it work?

It works in the sense that it is perfectly possible to sell short-dated bonds and buy the long-dated variety and in the process change the make-up of the Fed's bond portfolio. Beyond that, the picture is murkier.
Does it make a difference to interest rates?

The last time the Fed tried something similar was in 1961, when it managed to lower long-term rates by only 0.15 of a percentage point. That is the estimated effect according to some economists. In a 2004 paper, Fed chairman Ben Bernanke downplayed the strategy's significance as a tool for promoting lower long-term rates.
But anything is better than nothing?

With unemployment still high, households struggling to pay off debts and most banks refusing mortgage applications, whatever the interest rate, it seems unlikely that Operation Twist alone would make much of a difference.
Is there anything else the Fed can do?

It's funny how everyone is a monetarist these days, looking to the central bank to manipulate the supply of money to promote growth. Keynesians, who place more emphasis on governments improving sentiment and confidence to lift economies, have been sidelined. Bernanke could increase the size of his hand and buy more bonds across the board to depress short-term and long-term interest rates, but given the other barriers to lending, it seems like a policy that has run out of steam.

Dennis Ng - When You Master Your Finances, You Master Your Destiny

Note: I'm just sharing my personal comments, not giving you investment advice nor stock investment tips.
Post Reply