Fed’s twist: shift $400B in holdings
Noting risks of a further downturn, the Fed aims to lower long-term lending rates by essentially swapping $400? billion in short-term bonds for long-term bonds.
By Kevin G. Hall McClatchy News Service
WASHINGTON -- Digging deep into its bag of leftover economic sparkplugs, the Federal Reserve on Wednesday launched an unorthodox operation aimed at lowering long-term lending rates and thus sparking more spending and investment in an economy flirting with recession.
Specifically, the Fed announced it would sell $400 billion in short-term government bonds and replace them with longer-term government bonds of equal value.
The controversial action is dubbed Operation Twist II because it’s patterned after a similar move in the 1960s named after the then-popular dance craze.
By the end of June 2012, the Fed intends to buy $400 billion worth of Treasury securities with remaining maturities of six years to 30 years. In tandem, it will sell an equal amount of Treasury securities with remaining maturities of three years or less.
“This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the Fed said in a statement at the end of a two-day meeting. Three voting members dissented, saying it wasn’t needed.
While financial markets had expected the move, it was accompanied by a Fed statement noting “significant” risks of further economic downturn. That spooked investors. Stocks plunged. The Dow Jones Industrial Average shed 283.82 points, to 11,124.84.
“Operation Twist is the right thing to do, but it won’t help the economy much,” said Mark Zandi, chief economist for forecaster Moody’s Analytics. “Long-term rates, notably fixed-mortgage rates, are already at record lows, given investors’ anticipating the Fed’s actions today. But the Fed went a bit beyond expectations, and thus I think rates will go even lower. I expect 30-year fixed-mortgage rates to fall below 4 percent.”
Lower lending rates might spur more mortgage refinancing, home sales and business investment.
On its website, the Fed noted Operation Twist II is not a panacea, just another step that contributes to a “broad easing” in policies taken by the Fed, White House and Congress. It said that by driving down the interest rate paid to investors on long-term government bonds, “interest rates on a range of instruments including home mortgages, corporate bonds, and loans to households and businesses will also likely be lower.”
The Fed statement painted a bleak landscape: “Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed.”
