Thursday, September 22, 2011

Operation Twist A Real Hokey Pokey

You put your ten year in, you take your two year out
And you shake it all about
You hope for something different, but you haven't changed a thing
And the markets are left with doubt

The key element in the FOMC statement yesterday is "significant downside risk to the economic outlook".  This side note, coupled with the monetary sterility of Operation Twist, has sent global financial markets into a tailspin.  The knee jerk response higher in the US Dollar should not come as a surprise to those that have watched global financial markets collapse in unison in the recent past.  When global investors and traders sell, the first stop is always cash, and the US Dollar is "still" the global reserve currency.  This cash stop is always temporary.  The Fed's Operation Twist hardly makes the US Dollar a profitable home.  At best, the US Dollar is a Roach Motel for the cash of global traders and investors.

Don't Expect The Dollar To Tank After Bernanke & Co Hit The Dance Floor To Swing
By Agustino Fontevecchia
9/21/2011 @ 2:24PM
The greenback tanked during QE1 and QE2 because real interest rates had room to fall and the global banking sector found itself strong enough to fuel further U.S. dollar-credit creation. With European banks on the brink of collapse and real rates near 0%, more help from Ben Bernanke won’t result in further USD weakness.

Both previous rounds of QE helped to materially weaken the dollar because they had substantial and direct effects on key macroeconomic variables (i.e. interest rates) and on cross-border capital flows.

While real rates on 10-year Treasuries stood at 3.1% when QE1 was unveiled and at 1% at the time of QE2, they now stand at 0.0% as TIPS indicate, Nomura’s research indicates. “Market-implied real rates suggest that there is limited potential for monetary easing to generate a material shift,” explain the analysts. This time around, the Bernanke will have a much harder time “affecting expectations in a way that will provide a stimulatory impact.”

In other words, Operation Twist is sterile, there will be no flood of Dollars coming into the markets as a result of this latest Fed "operation".  The Fed is simply rearranging the deck chairs on the Titantic, and doing nothing to fix the hole that is sinking the ship.

With the global economy already gasping for "cheap Dollars" to bailout defaulting sovereign nations, Operation Twist just made Dollars harder and more expensive to get, despite the recently announced global US Dollar swap between the Fed, the Bank of England, Bank of Japan, European Central Bank and the Swiss National Bank  [In recent weeks, the deteriorating euro-zone sovereign debt crisis has spread into concerns about the region's banks, sparking a shortage in dollars and inflating short-term borrowing costs.] Operation Twist not only does not make US Dollars more freely available, but it will increase short term borrowing costs as short rates rise and long rates fall as a result of the operation.

Money and markets Mike Larson sums up the Fed's Operation Twist:

Meanwhile, in this afternoon’s Fed announcement, Bernanke may as well have just said, “America, we’re out of bullets. You’re on your own!”

The announcement turned out to be pretty much a non-event: The Fed announced that it will sell short-term treasuries valued at $400 billion — and then buy longer-term treasuries valued at $400 billion.

Net effect: Short-term yields may rise somewhat. Longer term yields may decline a bit. Nothing in this announcement has a snowball’s chance of stimulating the economy or reducing unemployment.This is nothing more than the Fed’s attempt to look like it’s fighting for the economy while it’s actually surrendering to forces beyond its control.

It’s tantamount to re-arranging the deck chairs on the Titanic. Total impact on the U.S. economy: Virtually nil!

Dollar Stronger After Fed's Operation Twist
With the more dollar-diluting of the Fed's options off the table for now, the greenback surged against the euro, yen and U.K. pound.

"It's what the market has been expecting, but I'm not convinced it's what the economy needs," said Ron Florance, managing director of investment strategy for Wells Fargo Private Bank. "But something is still better than nothing."

Why Traders Booed the Fed's "Operation Twist' – And You Should, Too
By Kerri Shannon, Associate Editor, Money Morning
With "Operation Twist," U.S. Federal Reserve policymakers are attempting to use an old strategy to launch a new attack on the wheezing U.S. economy.

But the assault, announced after the central bank's Federal Open Market Committee (FOMC) meeting concluded yesterday (Wednesday) afternoon, isn't expected to have much long-term success.

"The way [Fed policymakers] handled this proves that the Fed doesn't have much power left," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "It tried to use big sweeping statements, and careful language ... and it still didn't work - the market sold off ... and traders [on the trading floor in New York] actually booed. They don't want this ... they know it's bad."

With "Operation Twist," the objective is to get corporations to spend some of their cash hoards, and push investors out of safe-haven U.S. Treasuries and into stocks.

"They're literally trying to force scared consumers and scared investors into the market," said Money Morning's Fitz-Gerald. "They're trying at the same time to free up that logjam of funds that corporations are, in fact, sitting on."

The Fed also announced plans to reinvest maturing mortgage debt into mortgage-backed securities (MBS) instead of Treasuries, and reiterated its policy to keep the target range for the federal funds rate near zero.

But Fitz-Gerald said such stimulus measures have never helped the economy in the long-term.

"Long-term implications haven't changed ... we still have lots of problems here," said Fitz-Gerald. "The economic system is very different from the market system, and that's the underlying issue here. The Fed has been wrong about this all along. And what it's doing now proves that it's still wrong."

"We expect the Fed's actions to have very little visible effect on the economy, because the level of interest rates and the shape of the curve are not the key constraints on growth," wrote Ian Shepherdson from High Frequency Economics. "Mr. Bernanke wants to be seen to be doing something, but his hand is not on the fiscal policy lever."

Operation Twist Set To Fail As Bernanke Insists On Flattening The Yield Curve
By Agustino Fontevecchia
Will this work?

What the Fed is doing is flattening the yield curve in order to ease financial conditions and credit creation and shift capital “from investors and lenders to consumers,” explains Richard Bove of Rochdale Research. The Fed has also pledged to provide additional support for mortgage markets by reinvesting agency debt and MBS directly into more agency MBS in the secondary markets, as opposed to putting it into Treasuries. (Read Risky Business: Fed Should Buy More MBS).

The idea is that in a consumer economy, shifting money into risky assets and from investors and lenders to consumers will spark consumption. A portfolio balancing effect should spark a wealth effect by which investment in productive, albeit risky assets, spurs job creation, rising wages, and aggregate (consumer) demand which in turn feeds the whole cycle.

But the theoretical approach is fundamentally flawed, according to Bove. “By flattening the yield curve,” explains Bove, “Operation Twist reduces the incentive of the holders of funds to provide funds for production and real growth” by putting incentives in place for money to go short, not long.

A flatter yield curve reduces the availability of long-term capital and gives back the incentive to relocate those funds into short-term endeavors to maximize profits. It fuels the hyperbolic rise of gold and pushed firms to continue to build up their cash position, explains Bove, and investors and consumers to look outside of the U.S. for yield. (Read The Failure Of QE2: A Look At Gold, Oil, Equities, Treasuries, Emerging Markets, And The Dollar).

Fed’s Operation Twist Isn’t Much to Shout About
By Daniel Gross
The Federal Reserve has announced its latest effort to jolt the economy back to life. In the widely anticipated move, dubbed Operation Twist, it is pledging, over the next nine months, to sell some $400 billion in short-term government bonds it owns and use the proceeds to buy government bonds that mature in 6-30 years. The theory: This market intervention will help further lower long-term interest rates. The Fed also said that when mortgage-backed securities it owns pay off, it will roll the money back into similar securities. That could help push mortgage rates down.

There are some reasons why we shouldn't have great expectations for this move.

First, the Federal Reserve moves with all the surprise and guile of a lumbering elephant. It talks about moving, says what direction it might go in and at what speed, and provides a specific date on which it will act. It does so because it wants to avoid spooking the market. But it also means that the market tends to react well ahead of the actual event. Look at the path of the 10-year bond over the last several weeks. The interest rate on the 10-year bond has fallen from 3.2 percent on July 1 to about 1.9 percent today. The mere anticipation of the Fed's move has caused the market to do much of the Fed's work.

Second, given how low long-term interest rates already are -- they've fallen by 40 percent in the past three months -- this action is like pushing on a string, or adding another drop of water to a full pitcher. Pick your metaphor. Long-term borrowing costs for creditworthy borrowers are already at Crazy Eddie levels -- they're so low, they're insane. In August, according to Freddie Mac, the average commitment rate on 30-year mortgages it backed was 4.27 percent. Disney in August sold 30-year bonds that yielded 4.375 percent. Google in May sold three-year notes that pay a paltry 1.25 percent in annual interest. The government borrows for 10 years at less than 2 percent. That's all to the good. These lower rates help free up more cash for some people to spend, help corporations pay their bottom line, and lessen the fiscal bite of high deficits. But when you get close to zero, it becomes harder to make a bigger percentage difference. Money simply can't get much cheaper.

In conclusion then, lower interest rates have done little to improve the economy, why should we, or the Fed for that matter, believe that even lower interest rates is going to boost the economy?  We live with a monetary system based PURELY on debt.  If the Fed cannot encourage consumers and customers to take on more debt by making the debt cheap, the economy will collapse.  Never forget, the creation of debt is what ultimately fuels the money supply, short of actual money printing.

But Operation Twist has made money so cheap, nobody can afford to save it.  Despite Fed claims of "no inflation", real interest rates are grossly negative.  Negative interest rates are the best friend Gold could have.

Negative Real Interest Rates Continue to Provide Gold With a Perfect Environment
by Ronald Stoeferle
Inflation has never been the primary driver of the gold sector on its own. Given that gold, as is well known, does not pay interest, the real interest rates equal the opportunity costs. During the 20 years of the gold bear market in the 1980s and 1990s, real interest rates were about 4%. They were negative in only 6.7% of the months. The situation was completely different in the 1970s. Real interest rates were negative in 54% of the months. Since 2000 real interest rates have been negative in 47% of the months, which constitutes an optimal environment for gold.




1 comment:

  1. They're literally wanting to force scared buyers and scared traders in to the market
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