I'm not a big fan of this Operation Twist 2.0 that the Fed is trying. They have shot their monetary policy wad a while back when they drove short term interest rates down to zero (or at least under 0.25%), putting themselves in a classic liquidity trap, where the economy fails to respond to any additional money pumped into the system.
Usually, the Fed has short-term debt, mostly from the US Treasury, in the mix. Here, they're redoing their portfolio, selling off some of their short-term stuff and buying long-term debt in its place. In theory, this should lower long-term interest rates, as a reduced supply of longer-term T-notes and T-bonds will raise their price and (since price and yield go teeter-tottering in opposite directions) lower interest rates. That would then lower the cost of raising money for both individuals and businesses, making mortgages more affordable and making marginal projects that might not pass present-value muster at higher costs of capital doable at a lower cost of raising funds.
There are two main problems with that premise. The first is that it leaves the Fed vulnerable to a hike in interest rates. Since the value of a dollar is largely backed up by the Fed's stash of investments, getting a portfolio with a longer duration leaves it more sensitive to changes in interest rates; the longer a bond has to go, the more you have to suffer the lower rate you're now stuck with and the bigger the hit its price takes if you sell it early. Much as banks suffered in 2008-9 when their mortgage portfolios took it in the neck, the Fed might suffer if their twisted portfolio goes down in value.
Secondly, the problem is not as much with interest rates but with confidence in the future. The feeble European economy coming to grips with too much government debt in the Eurozone has markets queasy, and the increased scope of government, with business and their owners getting hit with more regulation (including a looming mandate to cover health insurance for employees) and possibly higher taxes, has expansion plans for businesses frozen in many cases.
That uncertainty will be on the table through November of next year, when markets will see if they have to deal with the Obama team through 2016 or not. The president kept saying that we can't afford to wait 14 months, but unless he and VP Biden are willing to resign now and cut to the chase, we're likely to have things stay sluggish until then.
The Fed is in "do something!" mode. The Twist 2.0 is like giving a dead man an enema; it can't hurt. It could hurt if interest rates rise and the Fed takes a hit, but for now, it's doing something.
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