With Operation Twist the FED has control of the long end of the curve.
Let that sink in…
What will the FED do with that new power?
Many of us know the yield curve is inverted. The yield curve must not be inverted.
The inversion of the curve is not something I have followed in any detail to be honest. I have no thoughts on this topic yet. This is now the most pressing topic before us, guessing what the FED does next.
The U.S. Federal Reserve (the Fed) implemented the Operation Twist program in late 2011 and 2012 to help stimulate the economy. The operation gained its nickname due to the Fed’s initiative of buying longer-term Treasuries (to raise the prices and lower long-term Treasury yields) and simultaneously selling some of the shorter-dated issues (to lower the price and raise short-term yields) it already held (to in order to ease the economy by bringing down long-term interest rates.
That program was terminated years ago. I don’t know why you are bringing it up now.
Currently, the Fed is doing the opposite. It is (very gradually) selling long-term Treasury and mortgage bonds. Selling those bonds could slightly raise the yields but the effect is too small to make a real difference in this gigantic global market.
Wendy
While reading my OP remember the US Treasuries are a global systemic risk. This was not just in light of the UK meltdown. This also was looking at Japan and others beginning to sell US paper.
Wendy, this will be more Treasury doing the buying. The twist can be in either direction. The purpose can be in either direction. Yields on the long end of the curve currently could skyrocket. Yellen will reign them in but to what level? The curve wont be inverted by the time the dust settles.
Need to add this was agreed upon late last year between Yellen and Powell. I do not fully know how it will operate. The FED will have ideas and may even instruct the Treasury since that is within the power of the FED. The Treasury is the instrument for buying this time. That seems to have been Yellen’s idea.
To think she once lost a job because her boss was a dolt. He claimed he fired her for being short. Talk about misogyny.
I just added this note to the bottom of the linked thread.
Adding Note March 17, 2023
As this all unfolds the long end of the curve will rise. The FED/Treasury will let the curve’s inversion resolve. This means higher yields at the long end of the curve. The long end of the curve will be controlled mostly so there is no spiraling higher out of control in a crisis.
Higher yields cut off inflation.
Expect a rising unemployment rate in the 2H23
Expect gold, btc and eth to rise. Expect equities to fall.
I do not see how that is possible–unless the US govt starts issuing new debt in massively higher volumes. I do not see that happening.
Other countries own US debt securities, but they can only sell that debt at essentially discounted market rates. They can NOT create new/additional US debt. Once they sell what they own, the market pricing reverts to being based on duration and interest rate of the debt.
@Leap1 I appreciate your thoughtful analysis.
Let’s look at some historical yield curve data.
We will look at four sources of data. The Treasury yield curve, the fed funds rate, the 10 year Treasury yield and the 10 year minus 3 month Treasury yield spread. I will post the links at the bottom.
There are two charts on the dynamic yield curve page. The one on the left shows the yield curve. The one on the right shows the S&P500. There is a vertical red line on that chart. Grab the red line with your cursor and slide it to the left. This will cause the yield curve to shift to the date of the cursor. I have spent a lot of time studying how the yield curve responded to different economic conditions, from recession to boom.
The normal yield curve is sloped upward. Yields at short durations are lower than yields at longer durations since investors want to be compensated for the risk of tying up their money for a long period of time. This is the rule during economic good times.
When the economy slows the long-term Treasury yield falls. This leads to an “inverted” yield curve when the long-term bonds yield less than the short-term. This causes the Federal Reserve to cut the fed funds rate (short-term) to stimulate the economy. That’s why the 10 year minus 3 month Treasury yield spread becomes negative before a recession but goes positive before the recession starts – because the Fed is cutting the short end yield to try to avert the recession.
In no case has the long yield continued to rise once the Fed started cutting rates. Look at 2000-2001, 2007-2008 and 2019-2020 (pre-Covid).
Our current situation is rather unique since the Federal Reserve created the inverted yield curve by rapidly raising the fed funds rate during the past year. If history is a guide, the long end of the yield curve will not continue to rise once the Fed stops raising the fed funds rate. In every previous case in the past 25 years, the long end has dropped once the Fed stops raising.
Today’s situation is rather unique because of the banking crisis. I will look at this in the Control Panel tomorrow.
Wendy
This is a bond market crisis. The bank failures and stresses are only the symptoms.
The selling of US paper raises the long end of the yield curve. The US Treasury/FED will control the valve. Other wise the long end of the curve would spiral out of control.
Jerry,
As the long end of the curve rises the yield getting more discounted, foreign and domestic institutions will sell to avoid a further discounting. The selling will be under stress.
There is no reason to sell unless they need the cash (for whatever reason). They paid for security of their investment, they got it.
People are leaving the banks for the better paying money market funds at brokers.
Then they sell those investments when the market goes RISKY again–and they buy what? US Treasuries… It is convenient when they choose and then they complain about it when rates go up and they want to get out of safe investments.
Jerry,
I am not in the know what other people buy later.
By definition, we are talking macro market stuff, not individuals who may choose to NOT follow market trends on each and every purchase/sale they make. However, we ARE talking the overall market, and what I stated is true and has been the path followed by much of the market for a very long time.
When times are good, investors are less worried about risk and more interested in ROI of invested funds. When times are hard, investors are less interested in ROI of invested funds and more interested in being sure their capital will be returned. In risky times, especially given the contrast been the 1990s, the 2000s and 2008-present, we see it very clearly. US debt is loved during high-risk times because it is a virtual certainty there will be no loss of assets to the buyer.
Jerry,
You missed it. I do not think investors are rational. I have no clue what the bulk of them will do next. Macro being bulk.