[Author’s Note: Thanks for your interest in this article. This article has been published on Yahoo! and a slightly expanded version on Seeking Alpha. Feel free to check it out there if you would like.]
Yes, we know that Operation Twist expires at the end of June, and the Federal Open Market Committee meets in less than three weeks. But let’s get serious. We have now reached the point where U.S. Treasury bond rates plummet to record lows nearly every day. In this environment, does it make any sense to actively manipulate these rates even lower?
History
Back on September 21, 2011, the Federal Reserve announced the Maturity Extension Program and Reinvestment Policy commonly called “Operation Twist.” Through this action, the Federal Reserve seeks to reduce long-term interest rates by selling its short-term (3 years or less) U.S. Treasuries and buying long-term (6 to 30 year) U.S. Treasury bonds. While Operation Twist is considered “balance sheet neutral,” it does elevate risk. In fact, it further compromises the already highly leveraged Federal Reserve holdings by increasing its exposure to loss when interest rates rise.
Appeasing Wall Street
But what about the stock market? If the Federal Reserve withholds any accommodation, the stock market will crash. The truth is, the stock market is quite capable of crashing on its own—despite the best efforts of the central bank. Unless the Federal Reserve comes to grips with the forces that make capitalism work, the economy will continue to languish and drag the stock market down to an even more severe, albeit prolonged, descent to the depths. We need only look at Japan to see the havoc wreaked by prolonged, perpetual, unnaturally low interest rates. Chairman Bernanke himself stated as recently as his April 25, 2012 FOMC Press Conference that the Federal Reserve cannot base its actions on the perceived needs of Wall Street:
…the purpose of monetary policy is to achieve our objectives of maximum employment and price stability. It’s not to disappoint or not disappoint investors. So we will take actions based on those economic objectives and not try to achieve certain market outcomes.
Distortion
This distortion of rates has become increasingly apparent as U.S. Treasury bond rates regularly cascade to new record lows. A 5% daily swoon in the 10-Year U.S. Treasury Bond rate is now commonplace. The stated, anticipated objective of Operation Twist was to effect a decline in these rates in the neighborhood of “about 20 basis points.” Even before the announcement of the program hit the streets, the rate on the 10-Year U.S. Treasury Bond had, in just four months, descended from the 3% to 3.5% range to 1.87%. Today, that number sits at 1.47%. In a little over a year, we’ve experienced a decline of about 200 basis points. The current rate now stands far below the lowest levels seen even during the depths of the 2008 financial crisis.
For all the positive benefits Operation Twist may have produced, the action has morphed into another cord in the serpentine noose which strangles initiative, robs the prudent, harms pension funds, fosters continued profligate Federal spending, and misdirects investment capital. Must we continue to throw gasoline on a fire? Enough is enough. It’s time to end Operation Twist.