The economy stinks. You and I know it, and the Federal Reserve knows it, too. That’s why they announced Operation Twist earlier this week. Operation Twist? What’s that, you say? It’s yet another attempt to drive interest rates down in hopes of spurring economic activity.
This time around, they’re targeting 10-year bond Treasury rates because lots of interest rates, including mortgage rates, are tied to the 10-year bond rate. In short, they’re planning on selling some of the shorter term bonds that they’re holding and using the proceeds to buy longer term bonds.
More specifically, over the next nine months, they intend to sell $400B in short-term government bonds and use the proceed to buy longer-term bonds. As demand for these longer-term bonds rises, their interest rates will fall. This makes sense, as you don’t have to pay as much interest to find buyers in a high demand market.
So… The big question is whether or not this will work. In this case, we can actually look to the past, as the Fed has tried this once before. In the 1961 rendition of Operation Twist, the Fed succeeded in bringing longer-term interest rates down 0.15%. Not much, but more than nothing.
For his part, Fed Chairman Ben Bernanke has previously downplayed the strategy’s potential as a tool for reducing long-term interest rates. So why bother? I guess when you’re running out of ideas, you’ll try anything. The bigger question to me is whether or not an interest rate reduction will have a meaningful economic effect.
Consider for a moment the housing market…
Do you honestly believe that there are legions of prospective homebuyers sitting on the sidelines because mortgage rates are just too darn high? With 30-year fixed rate mortgages hovering around 4% and 15-year fixed rate mortgages below 3.5%, mortgage money is already dirt cheap. What difference will it make if rates drop a bit further?
While the housing market is just one piece of the puzzle — albeit a big one — rates are low across the board and we’re still struggling. Maybe if the Feds would start paying people to borrow, we could get the economy back on track… Then again, in inflation-adjusted terms, they’re practically doing that already.
7 Responses to “Operation Twist: Even Lower Rates Ahead?”
Adam, The fed is also going to be buying mortgage backed securities which should have direct impact on mortgage rates. But even if they weren’t doing that the lower treasury rates also has a ripple effect on other interest rates.
The Fed has already done all it could do. It is now up to the Gov’t to make fundamental changes to the system. to avert an economic collapse. An immediate end to wars and a gradual end of entitlement programs could avert such a crisis.
I think this is a better idea than more QE. The interest rates being where they are should spur expansion and investment, but it’s just not happening because nobody has any faith that everyone else will follow suit. They aren’t really trying to drop rates any more, only maintain them while confidence builds on it’s own.
Banks won’t loan money to a business unless they think it will succeed. The current perception is of a very fragile economy with limited opportunity for new business ventures. I’m not convinced that the economy is as bad as all that. Savings rates are good, unemployment is high, but not on a global reference point. Manufacturing is doing fine and there is opportunity for exports. Every time the POTUS or congress talk about influencing the economy the market responds negatively.
If an action is to be taken by the Fed I think a relatively conservative action like Operation Twist is a good idea.
Mortgage rates are tied to mortgage backed securities and not 10-year bond rates.
It might not spur an uptick in home ownership, but it does leave those who are buying or refinancing a little more cash each month to spend on other things and thus have a stimulative effect.
Why are mortgage rates tied to the 10-year treasuries when most mortgages are 30 years? Wouldn’t it make more sense to tie rates to the 30-year treasuries?
I agree that this will do little to stimulate demand. The problem is the lack of confidence in the economy. Those who have jobs are afraid for them and have no visibility for the future. Companies are hoarding cash and banks aren’t lending but are increasing credit card interest rates. I will be paying off debt instead of spending.
I don’t think this will do much of anything and basically the Fed thought so too if you read the outbrief of the meeting. They are grasping at straws. It’s up to us to create jobs, and by us I mean Americans and American companies. Unfortunately, the geniuses on the Hill can’t and refuse to agree how to create an environment where job creation is fostered.
There really isn’t anyone left on the sidelines waiting for rates to go lower, because, as you already said, rates are historically low.